Canada's Housing Bubble

Dec 20, 2010 Barrie Mckenna theglobeandmail.com

Mark Carney rarely speaks without a clear purpose.

So when he warned ominously that Canadians have too much debt and need to change their behaviour, who was he talking to?

You and your neighbour? Not really.

Imagine you’re shopping for a house in Vancouver – the country’s most overheated real estate market. The average house price is $660,000. You figure out what cash you have available for a down payment, look at your monthly disposable income, shop around for the best interest rate, and then you figure out what you can afford.

Maybe you plunk down $165,000, and take out a 25-year mortgage for the rest at an annual interest rate of 4 per cent. Your monthly payment would be $2,612.

It’s doubtful you’d look to the central bank Governor for sage advice. Your father, maybe, but not Uncle Mark.

The decision to spend and to borrow, particularly on a big ticket item such as a house, is one of the most economically driven decisions you’ll ever make. There isn’t much you can do about cash on hand for a down payment or your income in the short-term. They are what they are.

And interest rates, house prices and mortgage rules (minimum down payment, maximum amortization period and the like) are beyond your control.

The inescapable conclusion to draw from this is that Mr. Carney isn’t really talking to you at all.

Mr. Carney, after all, helps control the ultimate lever to get Canadians to borrow less and deflate housing prices: raise interest rates. But in the current environment – a shaky recovery in Canada and elsewhere, high unemployment a soaring dollar – he’d really rather not go there.

That leaves the big banks, and there really aren’t that many of them. They have the ultimate power to rein in borrowing. They decide who gets to borrow, and how much.

The trouble is the banks aren’t interested in unilateral disarmament, no matter what Mr. Carney says. If one bank tightens its lending standards, the others would quickly rush in to steal market share in the lucrative mortgage business.

Toronto-Dominion Bank chief executive officer Ed Clark acknowledged as much in a Globe and Mail interview: Personal banking, he said, “is a highly competitive industry. If we said ‘Look, we’re going to be heroes and save Canada from itself, and we’ll impose a whole new [mortgage] regime on everyone else,’ the other four [large] banks would say ‘Let’s carve them up.’ ”

So the banks want Ottawa to be the heavy on tighter mortgage rules. After easing rules and inflating the housing market in 2006, the Harper government reversed course in its last budget to thwart Canadians from getting too deep into debt. They lowered the cap on how much equity homeowners can tap when they refinance and they raised the minimum down payment to 20 per cent from 5 per cent to get a government-insured mortgage on secondary residences.

Now, the banks want more, starting with a shorter amortization period (to 30 years perhaps from the current 35) and perhaps further restriction on equity withdrawals. Ottawa could also raise the minimum down payment required for all home purchases or prod banks to lengthen the typical fixed-rate mortgage period beyond the current five years.

Mr. Carney, a former Bay Street and Wall Street banker, knows the banks aren’t going to tighten lending standards on their own, no matter what he says.

And if all the major banks tightened lending standards simultaneously, it might well be illegal.

Let’s call a spade a spade. What the banks really want is for the government to sanction their mortgage-tightening cartel. They get to keep their market shares and nice profits. And the debt worries go away.

Mr. Carney is now the banks’ ally in prodding Finance Minister Jim Flaherty to do something. The Governor wants more prudent lending, and he doesn’t much care if it’s voluntary or legislated.

Mr. Carney knows that if he keeps rates this low for much longer, more borrowers will get into debt trouble. It’s economics 101. Low interest rates spur more borrowing, and almost certainly, more risky lending.

And the longer the Bank of Canada keeps rates low, the faster it will have to ratchet them up again in late 2011 or 2012, perhaps stalling the rest of the economy.

It’s all rather convoluted. But Mr. Carney’s debt warning looks a lot like a very public nudge to Mr. Flaherty and Stephen Harper.

Put aside the lively debate over whether homeowners really are too indebted. The question Canadians should ask is: Who benefits from tighter mortgage rules?

It’s not clear it’s you, or your neighbour.