Ottawa May Get What it Wants…and More

PrintBack in the spring, the feds were wishing that housing wasn’t so hot. They wished that mortgage growth wasn’t so robust. And now, CIBC chief economist Avery Shenfeld is telling us: “Ottawa has to be careful what it wishes for.”

Shenfeld issued that warning in this report released last week. He was, of course, referring to federal mortgage policies aimed at slowing residential real estate.

Some believe the extent of those policy changes (new high-ratio mortgage rules, new OSFI restrictions, new securitization and insurance limits, BASEL III, IFRS and so on) reflect a federal government playing with fire in the housing market. Others feel the measures are necessary to put out the fire, and prevent future ones.

Either way, stricter mortgage lending will take a bite out of economic growth. The country has just seen GDP fall for the first time since February (not a trend yet), in addition to posting a 15% drop in YOY home sales. There is certainly no reason to panic, but at the same time, no one knows where the housing slowdown, or its economic ramifications, will end.

Real estate activity has been the cement in Canada’s economic foundation. Seemingly singlehandedly, it helped the country recover from the global economic crisis well before most other nations.

Regulations-for-Mortgages-TighteningBut since 2008, the government has thrown the rule book at the real estate market. Its reductions to maximum amortization alone have increased monthly payments 26%, other things being equal.

That’s on top of new refinance restrictions, stricter qualification rates, a prohibition on high-ratio insured rental financing, stated income restrictions, covered bond restrictions, stricter documentation rules, HELOC LTV reductions, withdrawal of liquidity (rationed portfolio insurance), elimination of insurance on high-end properties, debt ratio limits, and much more.

Now, virtually every analyst in the country predicts a housing selloff of some degree.

So what happens next?

The answer hangs on how low the market goes. We will not see a U.S-style apocalypse (the reasons), but – if analysts are right – we’re definitely about to feel some pain.

The fact is, Canada’s economic fate is tightly intertwined with real estate. And below are 10 reasons why:

  1. One in five GDP dollars result from housing-related spending. (Source: CMHC). A 5% annual drop in house prices would shave a half-point off GDP growth “through its wealth effect on consumer spending,” says CIBC.
  2. Housing-related consumption and investment totals roughly $330 billion. (Source: CMHC)
  3. A $1 rise in the price of their house increases a consumer’s expenditures by 5.7 cents, much more than an equivalent rise in one’s stock portfolios. (Source: Bank of Canada research) Climbing home prices have boosted total GDP by 1.2% over the previous five years. (Source: CAAMP)
  4. The total value of owner-occupied housing in Canada was $3.48 trillion in 2011 (Source: CAAMP).
  5. The average Canadian has 67% equity in their real estate assets. (Source: Scotia Economics). The average homeowner has equity of $214,000 (Source: CAAMP), with significant reliance on that equity for retirement. In total, homeowners have about $2 trillion of home equity. (Source: CAAMP)
  6. net-worth-in-housingForty per cent of our net worth is in housing assets (Source: Bank of Canada). That’s “roughly equivalent to their investments in the stock market, insurance and pension plans combined,” says BoC head Mark Carney. If housing assets dive in value, consumer confidence plummets.
  7. For the last 10 years, Canada has averaged 460,000 home resales a year. (Source: Scotia Economics) That’s on top of new housing starts of roughly 200,000 a year.
  8. Housing and mortgage activities create significant employment in Canada. They account for more than 1.35 million direct and indirect jobs – about 8% of total Canadian employment. (Source: CAAMP)
  9. The construction sector employs 890,000 people. It has created 425,000 net new jobs in the past decade (Source: Scotia Economics) and 18% of job creation from 2006 to 2011 (Source: CAAMP). A major housing selloff could eliminate 115,000 of those positions, says Capital Economics. In a labour market that generates only 19,000 jobs a month on average, that is material.
  10. Renovation spending in 2010 (latest data we have) was $45 billion. Reno-spending will certainly be curtailed by new rules limiting equity take outs (ETOs). About $17.5 billion of those ETOs were devoted to spending and investment in 2011 (Source: CAAMP). Renovations have been the #1 reason people refi to pull out equity.

So much of Canadian’s wealth is linked to housing. A home is “the single biggest investment most Canadian households will ever make,” says Carney. Therefore, improving housing stability is a worthwhile goal given what’s riding on it. (More on that)

Ideally, Canada would have a more diversified economy that’s less dependent on housing. But we have what we have. Strong sustained manufacturing growth is not on the horizon, and resources like energy exports (6% of GDP) and forestry (1.9% of GDP) will not offset a significant housing slowdown.

Jim-FlahertyOne hopes that policymakers bent on retooling our housing system would have realized that. We want to believe they have this all figured out, and have calculated how to let the air out of the housing balloon slowly. But it really comes down to a “judgment call,” says Finance Minister Jim Flaherty. So the unknowns are immeasurable.

For now all we can do is watch home prices decelerate. If this leads us into the next downturn, we “will see greater than normal credit losses…” says Shenfeld. These losses will surely be exacerbated by the stacks of regulations that have been forced back-to-back onto an overvalued real estate market.

Given that risk, the BoC’s well-intentioned warnings (to pay down our debt or face higher rates) seem somewhat impotent. At this point, normalizing interest rates or adding significant new housing restrictions could be economic suicide. That makes both a low probability well into next year, possibly beyond.


Rob McLister, CMT

  1. Love how over the course of the last six months, the theme of the housing and mortgage industry has gone from
    1. “The new regulatory changes won’t have an impact – Prices will never go down and a house is the safest investment you can make – Buy now or never” to..
    2. “The new regulatory changes will only have a minor impact – Prices will continue to climb or hold steady obviously – Take the opportunity to buy now” to..
    3. “The new regulatory changes are driving prices down but we won’t see a US style meltdown – Take advantage of the balanced market to get in now” to…
    4. “Think of the little people who depend on the industry for an honest living (like myself)! Think of the impacts (to my family) when the illusion of the wealth effect disappears! Please change the rules (to save me)! Help the little people! – Also, buyers – don’t forget to take advantage of this buyers market to get in now – it’s only a soft patch”
    Deplorable – If I were someone foolish enough to listen to the rhetoric that comes out of the industry, I would be very confused (and about to be bankrupt).
    Your article completely ignores the fact that the market was in a state of major weakness(particularly in BC) well in advance of the new rules. It was an unsustainable house of cards to begin with and will implode with or without regulatory changes. Good night.

  2. There is nothing in this article about the
    “bailout that wasn’t a bailout”, the term
    which was coined by Stephen Harper.
    Both the Canadian and and U.S. governments participated in this bailout, totalling
    hundreds of billion dollars through the CHMC
    to take toxic mortgages off of the Big 5 banks’balance sheets.

  3. Yes, correcting mistakes is painful. Much better not to make the mistake in the first place, but when you are drifting off the road you can’t just leave it and wait and see whether it might fix itself.
    If the regulations hadn’t been loosened we wouldn’t be in this dangerous situation.
    Ideally, Canada would have a more diversified economy that’s less dependent on housing. But we have what we have.
    But why is it so housing-dependent? Well, the loosening of regulations around CMHC artificially boosted the sector so many people changed careers because that’s where the money was. By bringing the situation back to normal the government isn’t just throwing up their hands and giving up at the economic imbalance, they’re actually trying to fix it.
    If this leads us into the next downturn, we “will see greater than normal credit losses…” says Shenfeld.
    It is interesting how low default rates are held up as a strength of our system, but now that the risk of dropping prices is here, someone finally admits that they are a lagging indicator, and don’t actually mean anything about the strength of borrowers as long as prices are still rising.

  4. Another intelligent, balanced and well researched article Rob. We are lucky to have you in our industry.
    The fact is the government knowingly caused a slow down in the real estate market today in an attempt to avoid a bigger problem tomorrow; if the taps were left wide open for another year or two.
    There is definitely going to be pain and the government knew there would be. The people in charge thought that it would be better to have some pain now rather than a whole lot of pain later. That certainly does not make the people feeling the pain any happier but its the way things work in a cyclical market. Truth is: those of in the this market for a long time know we have had a very good run.
    I am not an apoligist for this federal government, I am not even a fan of the government but the fact is they felt they had to do something and they did.
    We will never know if it was the right thing to do because history moves on, we will never know everything would have worked out fine if the feds had left mortgage rules alone and refused to adopt B20 or whether if there would have been a horrific real estate debacle in 2 or 3 years when the rates started moving up. We just don’t know.

  5. One good side – BoC won’t increase the rates soon.
    And until the whole system isn’t modified slowly (maybe that’s the goal) there will be no change.
    As you said – no other industry sectors are expanding too much.
    So the way to go is – less borrowing, lower rates, lower debt levels. And whoever has too much free money … too bad, use them or let inflation eat them slowly.
    New world Order maybe, who knows, but there’s nothing wrong in my view to spend only what you have, not using any credit.
    It’s a fake economy now, a financial pyramidal structure that relies to future to balance itself, but as we all saw – that didn’t work too well in US and Europe.
    My neighbor once said he built his house when he had money to do it, no loans from banks.
    maybe that’s the way to go :) but it will take generations.

  6. The Insured Mortgage Purchase Program provided liquidity during the financial crisis. It dealt only with prime mortgages that were already insured. Not exactly toxic.
    Here is a short summary if you want to educate yourself.
    The Insured Mortgage Purchase Program (IMPP) was introduced by the Government of Canada as a temporary measure to address the liquidity crisis. During the latter part of 2008 and early 2009, the absence of available funds made it extremely difficult for some consumers and businesses to get access to credit. This was a global phenomenon that started in the United States, quickly spread to Europe and eventually affected all countries that rely on global financial markets.
    The IMPP authorized CMHC, on behalf of the Government of Canada, to purchase up to $125 billion in National Housing Act Mortgage-Backed Securities from Canadian financial institutions, giving them access to longer-term funds for lending to consumers, homebuyers and businesses.
    Since these securities comprise insured mortgage pools that are already backed by the Government of Canada (through insurance issued by CMHC or private sector mortgage insurers), this program did not create any additional risk to the Government. In fact, the Government of Canada will earn a return on this investment.
    When the IMPP came to an end on March 31, 2010, CMHC had purchased $69 billion worth of mortgage-backed securities through auctions. This program was instrumental in moderating the impact of the global financial crisis on credit conditions in Canada and helping ensure continuing access to credit for Canadian consumers and businesses.

  7. BaySt nails this one. The same as TARP in the USA, this program stabilized a system in distress, averted a possible financial melt-down and ended up making a profit for a Crown Corp ergo…. us the tax payer. NOT a bail out.

  8. Sorry but that is one bad generalization “Anon.” You can’t speak for the entire housing and mortgage industry. I am in the mortgage industry and I can tell you this is NOT what I’ve been telling my clients.
    I see all too many comments like this from bitter people who add nothing intelligent to the debate. Maybe if you spent more time researching the issues and less time badmouthing people, your opinions would be worth something.

  9. Rob,
    I’m hearing that if there is a meltdown, Independent Mortgage Brokers will be the scapegoat. The Big Banks want it that way as they will have all the business post-crash (if there is one).

  10. “Your article completely ignores the fact that the market was in a state of major weakness(particularly in BC) well in advance of the new rules.”
    That isn’t how I read it. The article says that mortgage rules were thrust “onto an overvalued real estate market.” What else needs to be said?
    Your point has no merit regardless. With the exception of Vancouver, the housing market had barely started to slide at the time OSFI’s rules and insured mortgage rules were announced.

  11. “Real estate activity has been the cement in Canada’s economic foundation. Seemingly singlehandedly, it helped the country recover from the global economic crisis well before most other nations.”
    —————-
    Any economic activity which is the by-product of cheap and available credit is doomed to sputter once those credit conditions change.
    Real estate activity does nothing to enhance our export capabilities. The capital devoted to building monster homes and installing granite counter tops has been a massive mis-allocation of capital.
    Oil companies are going begging to international capital markets asking for buyouts since there is a lack of domestic capital to develop synthetic oil extraction and refining capabilities in Northern Alberta. Why? Look at the $600B which CMHC has in “insurance in force” and you’ll start getting an idea where Canadians have chosen to deploy our capital. Granite countertops look great but they don’t produce anything we can export, except the houseporn on HGTV.

  12. Bo,
    Unfortunately, exports aren’t the tail that wags the dog. Value-added exports account for a minority (less than $3 out of every $10) of GDP.
    Moreover, it’s important to remember what we actually export: http://atlas.media.mit.edu/explore/tree_map/export/can/all/show/2009/
    This stuff wasn’t exactly flying off the shelves during the great recession. The country was lucky that people kept spending, and housing was an important driver of that.
    In future economic cycles, perhaps we won’t rely as much on real estate as a catalyst. But the fact remains that housing-related spending helped get Canada through some tough times, and we still rely on it heavily.
    At the moment, Ottawa is in the process of diversifying the economy. That’s terrific, to the extent that (a) it’s done at a sensible pace, and (b) the replacement for housing activity is of equal or greater net economic value.
    On the topic of misallocation of capital: The truth is, money isn’t stupid (for long). By and large, it flows to its best use. If folks had not made the housing expenditures they did, there is no reason to believe that capital would have been allocated to things like plants and equipment, especially during and following the recession.
    To your last point, there is ample capital for worthwhile assets/projects. PwC said last month, “The drop-off in (M&A) activity is attributable to an absence of targets in the market, rather than an absence of demand for deals.” Any investment apprehension is primarily reflective of the quality of the opportunities (or lack thereof), economic conditions, or both.

  13. ….where were these changes 5 years ago?
    I’m sure our Bankers had nothing to do with changes…
    Maybe 5 years from now, we will see changes again to “stimulate” growth.
    Who wins with the current rule changes?
    Hmmmm….your renewal choices (assuming your don’t fit in the round hole) just became a lot more expensive. Your Bank knows and it now doesn’t have to discount your rate that far to keep you.
    The brokers? they are too fragmented to make a difference. none want to stick out as they know they still have to play nice with the lenders.
    The government? hmmm…suddenly, there is an increase in the amount claimed under line 150…why is that?

  14. Nice. Refreshing change to see an informed and balanced opinion supported with facts. As BayST says, this was no bailout. It was a safe injection of funds into a market to address the unexpected liquidity issues going on at the time.

  15. “Your Bank knows and it now doesn’t have to discount your rate that far to keep you.”
    ..What discount??
    The big banks enjoyed Posted Rates for decades and will again. People that choose them over wholesale lenders are either new or have short memories ..but that’s the marketing machine of a bank cabal.

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  17. You do a great job Elizabeth. I’ve seen a noticeable improvement in comment quality over the last few months.

  18. “The truth is, money isn’t stupid (for long).”
    How long did the Egyptians continue building pyramids? Capital misallocation can occur over hundreds of years.
    Still doesn’t make them less wasteful or useless.

  19. Exceptions aside, money has got a little smarter in the last 4,000 years. Of course, where it’s invested will always be based on available information, which is sometimes incomplete!

  20. “Comment quality” … it’s a question of perspective.
    All comments mater as they are point of view . If you don’t want to receive all points of view, better stop receiving comments.

  21. Sure sounds like a bailout to me. The banks were short on cash so our gov’t bought their mortgage assets at a higher price then the banks could have gotten on the open market at the time. That price difference was the bailout.
    Also, this gov’t purchase did create additional risk for the taxpayer through CMHC. By providing liquidity that was then funneled into new mostly CMHC insured mortgages, the much needed house price correction of 2008 was put on hold and now we have an even bigger bubble to deal with. As default rates start to rise, the cost to CMHC and ultimately the taxpayer will be much larger than if we had just taken our medicine starting back in 2008.

  22. On the contrary. I’ve seen rude comments that are long on hype and short on facts. Those ones don’t matter one bit. They just waste everyone’s time.

  23. It’s not a bailout if the government profits from it.
    These mortgage purchases supported confidence while the country was in financial distress. If the choices are between making money off already insured mortgages or preventing a housing meltdown, there is no thinking required.
    Ps. There is no proof we’ll have a crash because of this, so save your breath.

  24. Hi Tomas, If that were true it would throw the concept of domestic consumption right out the window. Internal spending counts. Ask those who benefit from its multiplier effects and ask the government who benefits from its applicable fees and taxes.

  25. “Money has got a little smarter in the last 4,000 years.”
    Ponzi schemes were invented in the early 20th century. I would argue money has gotten more stupid.

  26. Charles Ponzi and Bernie Madoff were two of the reasons for “exceptions aside.” :) But swindles have been around for centuries and forever will. It’s the ratio of gullible money that’s the question. This is an interesting topic on its own, but alas we digress…

  27. I actually also agree with Anon because he’s right. And I too, am a mortgage broker who has done my research and knows the industry. I’m also not hear to offend or insult anyone (Paul.)
    Not necessarily this article, but banks have been begging the feds to step in and cool the market, because they simply can’t tell people “no” when (gasp!) that would mean losing profits! This was mostly TD, and not CIBC, but still….it seems as though Flaherty and Carney can’t win no matter what they do. After TD asked the feds to tighten rules, Flaherty asked them why they wanted him to run his business. Now he’s done what they wanted – and he still won’t hear the end of it. The housing market WOULD NOT have been able to sustain itself, and these rules were NECESSARY to save us from ourselves.
    If that means that the rules have more of an effect than intended, so be it. It’s exactly what we asked for – both with our words, and our actions.

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