Flaherty on Rates: How Low Can’t You Go?

Hot air balloons at the Taos Balloon festival 2007How low is too low when it comes to mortgage rates?

Apparently the answer to that question is 2.99% on a 5-year fixed.

Finance Minister Jim Flaherty wasn’t too happy that banks broke the 3% barrier on 4- and 5-year rates back in January and March. He implied that those rate promotions were essentially irresponsible with Ottawa trying to temper credit growth.

“I think they’ve moved away from offering sales on mortgage interest rates. That was something we discouraged,” he told the Globe & Mail recently.

Flaherty said he spoke directly to bank CEOs about it, warning them: “You should be cautious about your lending practices, because this is the type of practice that led to a mortgage crisis in the United States several years ago…So my expectation is that you will not compete to the bottom on interest rates.”

Jim-Flaherty“To the bottom” was “the direction they were going,” he added.

You don’t have to read too far into this to realize what we’re being told. That is: to ward off housing risk, it is now appropriate for the government to step in and implicitly govern mortgage rates.

To this, we should all be saying, “Sorry Jim, but this is taking your authority a touch too far.”

It is wrong on so many levels, not the least of which include:

  1. The arbitrariness of it all
    • From the looks of it, 3.19% for a 5-year fixed is okay, but pricing a scant 20 basis points below that (i.e., 2.99%) makes you a reckless lender.
  2. The hypocrisy of it all
    • The government’s very own policies (like its mortgage-backed securities guarantees, the Canada Mortgage Bond program, etc.) are actually designed, in large part, to keep mortgage rates low.
    • Moreover, the BoC has set Canada’s key lending rate at just 100 basis points above zero for the explicit purpose of fuelling consumption and lending.
    • Prime-rate commercial loans, 0% car financing, 1.99% credit card balance transfers, and 12-month no-interest furniture financing are all seemingly okay. But if someone wants to buy an asset that actually appreciates long-term (like shelter), lenders are doing them a disservice by offering more competitive 5-year rates.
  3. The anti-capitalism of it all
    • Are financial institutions supposed to lie down and accept government stepping in at its discretion to influence rates whenever it doesn’t like market pricing?
  4. The anti-consumerism of it all
    • Lenders would never offer 2.99% 5-year rates unless their cost of funds supported it. If the government wills rates higher in spite of record low yields, consumers lose and lenders win. The former pays more interest and the latter earns fatter margins and windfall profits. Are these the decisions that most citizens want their politicians making?
  5. The illogicalness of it all
    • A 2.99% 5-year rate doesn’t mean a borrower is automatically approved. Home buyers must still apply and meet normal lending standards—which are getting progressively tighter by the day, it seems.
    • The goal shouldn’t be to artificially inflate rates. Well-qualified homeowners have a right to pay less for their mortgage. The objective should be to curb risky lending. As an alternative, the DoF would be wiser – and more within its purview – to disregard market rates and focus on sensible solutions. One such solution would be requiring all borrowers to qualify at a higher rate (e.g., prime + 2%, posted rates, etc.).
    • If officials try to control pricing at major banks, smaller lenders will simply undercut them. Few Canadians shed tears for big banks, but strong-arming banks alone is inequitable. Any suasion to create an artificial floor in mortgage rates should be directed at all lenders.

********

“Government knows best” is starting to get really old, really fast. Before you know it, regulators will be providing handbooks to lenders on how to price mortgages, with a ban on all 5-year rates under 3%. Wouldn’t that be a perfect way to stop the “madness?”

On a less derisive note, it’s clear that policy makers are trying to slow mortgage lending and gently guide down the market. This essay isn’t meant to criticize good intentions or sound mortgage guidelines, only questionable policy.

Canadian-HousingBarring a prior home price collapse, the #1 driver of housing demand—affordability—is destined to deteriorate. When it does, it’ll slow the market in a way that 3.5 years of lending restrictions have not been able to.

In other words, when base lending rates increase and/or the latest round of mortgage rules kick in, the market will face additional (potentially serious) affordability constraints. Those headwinds will deflate market demand far more effectively than politicians micro-managing mortgage rates. Ottawa needs to realize that and give recent/upcoming mortgage restrictions time to run their course.

The danger with Canada’s deluge of mortgage tightening is clear. When the housing market eventually corrects, all of these counter-cyclical policies will turn into pro-cyclical policies.

Or, to put it another way, Ottawa’s mortgage restraints will start reinforcing the downward housing cycle. At that point, our soft landing risks becoming a hard landing, and it could take far longer for housing to recover.


Sidebar: It was hard to find any media reports on the reactions of bank CEOs to Flaherty’s mortgage rate “guidance.” One can only hope they politely reminded Jim of his very own words:

“…It’s their (the banks’) market; it’s not my market…They decide what they want to charge in interest rates.”


Rob McLister, CMT

  1. People should have to qualify at the historical average for mortgage rates then they should be free to choose any mortgage rate they want. People wouldn’t qualify for as much money and pay off their mortgages faster, and it would protect them against fluctuations in the mortgage rate over time.
    Lenders could also extend the low rate for the full duration of the mortgage ie. 20-30 years. Then we would see how low or high these rates should really be.

  2. You said it yourself Government is driving down mortgage rates therefore they have to regulate the market you can’t have your cake and eat it too.

  3. Couldn’t agree more. Does Flaherty tell the car companies what prices to sell their cars at? If the prices are too low, more people will borrow to buy them and that can’t be a good thing right?
    The whole mortgage scene is a bit nuts – on the one hand you have a finance minister asking banks to price their products less competitively and on the other hand you have Ed Clark (CEO of TD bank) suggesting that government intervention is needed to help banks approve less loans.
    As you point out, the government has other (proper) methods to discourage bank lending – none of which involve any discussion with banks or their clients. Telling people or institutions not to do something is a waste of time.

  4. What caused the failure in the US was that people couldn’t afford the mortgages in the first place. Banks were lending money truly irresponsibly.
    Having been in the business for over 20 years, I can say there are no major banks or credit unions that are lending money irresponsibly, regardless of rate.

  5. Good article Rob,
    The Gov is really getting out of control, I would like them to spend more time reducing the massive debt that is accumulating on Canadians back. Ottawa is out of control with its spending habits. This is the greatest threat to the long term viability of our economy, we need to look no further than Europe.

  6. Rob, I love your blog and learn a lot every week reading it. But I think this posting is quite off the mark. Your main point, as I understand you is that it is *not* appropriate “to ward off housing risk..[that] the government … step in and implicitly govern mortgage rates.”
    But it is governments, worldwide, led by the Fed, that are holding short rates and long bonds to negative real levels, so-called financial repression. Even if he wanted to (and I think he does), Carney could not raise rates without causing the Can$ to spike.
    So we are stuck with global *government created* negative rates. Myself, I think this is the right central bank policy, but even if you don’t like it, it’s a fact. Even if Flaherty and Carney wanted to change that, they can’t. Bernanke won’t change that so long as the US housing market is in the dumps.
    There is no doubt that negative real rates are fuelling asset inflation. How can they not? It’s a matter of mathematics. And any visitor to Vancouver and Toronto can see that. This asset inflation is partially beneficial, but it brings risks with it, like giving a patient on the operating table a powerful drug with some unpleasant side effects.
    Since the origin of the artificially low rates is global central bank policy, objecting to local governments taking selective action (limited to real estate rates) in what is clearly an overheated market on the strength of the argument that this is government intervention, thus undesirable, is paradoxical. It is as if one were to say, because of a belief in holistic medicine, that the side effects of the drug should not be treated, because that would be a medical intervention, although the cause of the side effects was itself a medical intervention.
    Conversely, for those opposed to the central bank actions–if operation twist and the associated euroland policies were ended tomorrow, rates would go up 1-2% all along the yield curve in short order, and you would see defaults on all types of debt worldwide.
    So I think Flaherty is doing just the right thing. But that is just my opinion.

  7. So I’ve noticed articles being posted here are becoming more biased. It’s funny how nobody complained when the authorities assisted bond purchases and deregulation to keep rates low and loosen underwriting practices, respectively. Might I remind everyone at that time, it was the pension funds and institutional money who said “Sorry Jim (et al), but this is taking your authority a touch too far.”
    Now everyone is kicking and screaming about self-regulating guidelines and returning the market back to private capital?
    All the BoC is doing is taking its foot off the pedal by reducing its bond purchases (rolling over treasuries now), while OSFI is reimposing guidelines that banks and lending institutions were not following.
    Is that what you consider anti-capitalism?

  8. yea where was flaherty when mortgage rates were pushing 20 per cent a few years back? give us a break buddy….let us enjoy some low rates for a bit and actually have some extra cash left over…soon enuf we’ll get squeezed out and the boys in the ceo offices in the bank towers will be planning their next trip to the riveria

  9. Well argued article Rob. I agree completely. By dissuading lenders from freely (and legitimately)competing for business by providing the lowest rate to the client, F is necessarily punishing borrowers who would otherwise benefit.
    If its such a big deal that money is available for 5years fixed below 3%, just raise the prime rate and get it over with.

  10. I can’t believe this. The government takes 50 cents of every dollar I make. Now it’s effectively adding another tax by keeping us from saving a few bucks on our mortgages??
    Enough is enough. I pay my bills on time and manage to sock away a small sum each month for retirement. I don’t need big brother making it any hard for me to save. I’m sure Mr. Flaherty can come up with another way to achieve his ends without draining the pocketbooks of hard working Canadians.

  11. If government is already underwriting risk and now trying to price it, why doesn’t CMHC just go direct to consumer?

  12. Hi CW, You are absolutely correct that these articles are biased…towards the facts as we can best perceive them. As always, all opposing viewpoints are welcome. Thank you for yours…Rob

  13. Thanks David,
    It’s certainly prudent to “to ward off housing risk,” to the extent that Ottawa’s policies are commensurate with the actual risk.
    Where it’s not prudent is to govern in a knee-jerk fashion, whereby responsible homeowners are penalized by hasty efforts to thwart an unquantified threat.
    There are numerous ways to curtail risk and slow the market. Ottawa has chosen the most convenient way, a broad carpet bomb of policies as opposed to surgical regulations that attack the root risks. This approach creates economic collateral damage that could be worse than the problem being solved.
    There will never be an argument here against sensible regulation in general. But there’s a limit, and imposing arbitrary rate floors on private sector financial institutions crosses that line.
    That’s our honest take anyway.
    Cheers,
    Rob

  14. I hope Flaherty doesn’t involve anymore CMHC and leave the market to be free… There is no need for regulations.. only free market where the mortgages are not based on the “safe” CMHC. Everybody complains about his intervention but I would like to see no CMHC and give the banks the freedom to loan how much they want…

  15. If the concern is that some Canadians may be in over their heads when interest rates eventually rise, why not simply regulate and consider lowering TDS/GDS maximums, institute proper credit card minimum payments, limits and tighten bank fee regulations?

  16. I’m curious what a “responsible homeowner” in Canada defined as.
    In the U.S. it does not include anyone who purchased over a 15x price to rent ratio. (Sure, lots of people who overpaid are living up to their mortgage debt because it’s possible to, but they are not participating in the consumer economy as much because of it and like it or not, we are consumer economies.)
    It’s true that Flaherty’s recent moves and the OSFI switch are late and sudden. They should have been 5 years ago. Also annoying that Flaherty gets “credit” in the linked article and others like it for the tightening he’s done, but not responsibility for the loosening that necessitated the tightening in the first place.

  17. Hi emmi,
    When we write about “responsible homeowners,” we’re referring to Canadians who:
    * Incur reasonable debt loads
    * Build in a margin of safety (i.e., they have savings/liquidity)
    * Have the willingness, foresight and capability to service all of their debts on time, both today, and also in more challenging environments.
    Cheers…

  18. Bill C38 passed second reading Monday. It is now in a finance committee review. The third and final reding should be first week of June.
    Tick, tock.
    You’d be better off pleading for the gov’t to allow greater entry of US lenders.

  19. If the government is taking 50 cents of every dollar you make, you need financial and tax planning help, and fast

  20. Just another example of the conservative government getting involved when they should not. Last time I checked this was not a dictatorship, nor communist Canada… So why do the conservatives continue to buck democracy in all they do? They quash parliamentary committees, respond to debate in parliament with disdain, and now are trying to control free market. Harper and his cronies voted 100% against tighter bank regulations in the 90’s, then took credit for them, and now they are trying to manipulate free market. They got in on the basis of the need for stability? How is this flip flopping creating stability? They are only creating greater consumer uncertainty.

  21. I agree with you James, Harper and the conservative government are riding a power high right now. They have increased spending astronomically, have made several social funding decisions that have pushed thousands of Canadians on the streets, and have out and out lied to Canadians about several issues. This is just another tactic to keep Canadians in “fear” mode so that they do not realize what is truly happening. It’s a play as old as politics… Keep you citizens on edge and they will be too afraid to change current government. It’s how they got their majority in the first place.
    The sad reality is that the tactic works, and it means that they will likely win the next election. They did not even get 40% of the votes in the last election… But formed government, and are now making a great big mess out of our country.

  22. Why is it that the minute media prints a story based on facts that some people start to decry bias? I bet the same people who have commented here were not screaming bias during the past two elections when the only negative press was about the liberals… And it was… Check the history…. Harper could do no wrong.
    It’s a sad defense of a flawed government who is still hiding behind the skirt of the former liberal government… You know the one that legislated the tighter banking rules that saved our skin while Harper and the conservatives voted 100% against them.
    It was after all This conservative government that loosened everything and this is how they are reacting… Lest the public realize that it was they that dug the hole.

  23. For many people it’s probably more than 50 cents on the dollar. Don’t forget about GST, provincial sales tax, gas tax, alcohol tax, airport tax and the hundreds of other usage-based taxes, levies and surcharges.

  24. Uhm….with CMHC backing mortgages (that means taxpayers) yeah, slowing down the banks makes sense. Flaherty is having to clean up the mess he created when he allowed 0 down with 40 year ams…the hoser version of sub-prime lending.
    Of course RE industry hacks are going to be upset, the same way dope fiends don’t like the new MJ laws.
    At least this way when housing prices correct we might be able to avoid the implosion that took place south of the border.
    Regulations are needed because ultimately its taxpayers who are on the hook for the billions CMHC insured mortgages.

  25. How are taxpayers going to make out when housing cracks like a dry bone under the weight of stifling mortgage rules?

  26. Tick tock this. You get an A+ in exaggeration. C-38 gives CMHC a new supervisor and makes covered bonds uninsured. Wow! How will we survive?!?!
    It must get depressing to hope and wait every day for the sky to fall.

  27. I only know of the cliché that mothers know best. The line for me is never old though it seems cliché. It is if not always, most of the times, true. The line saying that the government knows best is not that effective to everybody.

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