OSFI wants to be proactive, in keeping with its “early intervention mandate.”
Canada faces debt risk and housing risk, and neither should be downplayed. OSFI is, to a large extent, doing what it feels it must and it is right to be ahead of the curve.
That said, here are some comments with which objective observers might take issue. Melessanakis writes:
“The (housing) market may break because the fundamentals are not sound (i.e., overvaluation of homes), not because of OSFI guidance.” (OSFI’s blanket wide-ranging underwriting restrictions will have an adverse influence on housing demand. This is absolutely undeniable. If this tips the market balance in favour of supply, then OSFI guidelines could indeed contribute to and/or spark a housing tumble.)
HELOC growth has “contributed significantly to growing overall household debt…If (or when) housing prices drop, households would be vulnerable.” (Two fair questions would be: how many households and how vulnerable? We have anecdotal evidence, but not enough good data to answer this. Hopefully OSFI’s data is sound, though it hasn’t shared any so we wouldn’t know. One thing is certain: HELOC borrowers are better qualified and face tougher approval standards than regular mortgagors. People with only HELOCs on their property have 81% equity on average, according to CAAMP data, so HELOC abuse is by no means epidemic. Moreover, if the HELOC taps are tightened, chronic borrowers will still borrow, but at higher and riskier interest rates.)
OSFI has not proposed carve-outs to its mortgage guidelines for strong borrowers who present immaterial default risk. To this, Melessanakis says: “Being ‘responsible’ is one thing, having the capacity to pay back the loan is another.”
(Capacity is not an issue with today’s sound borrowers. They have solid credit, equity, net worth and employment. Even with a 300 basis point rate hike, only 8% of the overall market would have a high total debt service ratio [i.e., one that’s above 40%], says CIBC. Naturally, only a fraction of these would actually default on their mortgages. Add to that a small number who would default for other reasons.)
The government is enacting mortgage tightening in a “staged manner.”
Arrears have only been stable and below U.S. and UK levels for the “past 5-7 years. See (banking) failures in the 1980s and 1990s.”
(In the modern era of housing, arrears peaked at 1.02% in 1983, according to CMHC. That followed a dire economic environment. For 20+ years, arrears have been very reasonably contained.)
“Are the banks equipped to handle a 40% (home price) drop—(like) what occurred in (the) Toronto market in (the) early 1990s?”
(This statement draws questions about Melessanakis’s market understanding. Toronto home prices peaked in April 1989 at $261,000 and fell 28% to $189,000 in August 1993. His 40% figure is baffling. Toronto sales comprise one-fifth of the nation’s housing market. But most banks’ risk exposure is spread across the entire country. Many would argue that stress-testing with a national home price drop of 40% isn’t realistic. Anything is possible but modern history doesn’t support it and 40% is well beyond projections from reputable economists, housing analysts, independent think tanks, etc. A national drop of this magnitude would take an epic economic catalyst. Overvaluation alone isn’t enough.)
Regarding CMT’s observation that it’s better to take “medicine” from a spoon than a ladle, meaning that too many rapidly adopted housing regulations could derail the market, Melessanakis replied, “What does that mean? Do nothing?”
(Perhaps Melessanakis might have been a bit frustrated at this stage of his comments, since “do nothing” clearly wasn’t our suggestion.)
Proactive lending safeguards are in our best interests to the extent they control irresponsible borrowing.
The risk is that the policy side effects are worse than the disease. A sudden and overly restrained housing market could potentially trigger the severe correction the government wants to avoid.
OSFI received a lot of pragmatic feedback during its comment period. Hopefully it genuinely considers all feedback, even that which differs from its own views. We’ll certainly do the same.
Rob McLister, CMT
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