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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.

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“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

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