Canada’s CMHC shames corrupt APRA on mortgage risks

While Australia’s captured prudential regulator, the Australian Prudential Regulatory Authority (APRA), is busy cutting lending standards, in the form of the shredded interest rates buffer, just months after the Hayne Royal Commission lambasted Australia’s banks for shoddy lending, and just five months after APRA said is was permanent. The head of Canada’s state-run mortgage insurer, the Canada Mortgage and Housing Corporation (CMHC), is taking the opposite stance, advising the Canadian Government to maintain strong macroprudential controls to prevent irresponsible lending, including maintaining Canada’s interest rate buffer.

In a letter to Canada’s Standing Committee on Finance, CMHC President & CEO Evan Siddall, warned committee members that any watering down of macroprudential controls would increase household debt, make housing less affordable, raise inequality, and risks blowing-up Canada’s banking system:

These policies have been wrongly accused of having “unintended consequences.” Public servants spend a great deal of time evaluating consequences and how behaviours might change as a result of policies in normal times and in times of financial instability — a state that is too often ignored. The call by some people for relief from the so-called “unintended consequences” of the stress test for mortgage renewals provides a good example. At first glance, this seems unfair.

Critics are however overlooking the fact that underwriting standards must apply in both good times and in bad. In a February 2019 speech, OSFI Assistant Superintendent Carolyn Rogers explained why renewals should not be exempted from the stress test. In brief, OSFI doesn’t want to stimulate competition among banks for weaker credits.

We can take the thinking a step further. Lenders often engage in pro-cyclical behaviour such as dumping assets in the face of a crisis, especially weaker assets, sending asset values even lower…

Easing of the stress test buffer is therefore not called for as rates rise. In neither case is an interest rate shock the underlying concern. OSFI will presumably want to maintain an underwriting buffer through the economic cycle. And we will continue to support it for insured mortgages until debt to income ratios moderate significantly in Canada. The single largest risk to an insured mortgage is the homeowner’s  unemployment — not higher interest rates. Our objective is to protect economic growth and jobs…

House prices tend to track growth of disposable income in the long term. Over the past 20 years, average Canadian house prices have increased by 3.8% per year while national income (GDP) has increased in real terms by 1.9% per annum. Gross household debt has increased from $539 billion in 1998 (106% of disposable income) to $2.2 trillion, or 178% of disposable income in the fourth quarter of 2018. Said otherwise, household debt has increased over 20 years from 58% to 99% of GDP and mortgage debt from 37% to 65%.

Our appetite for housing, both as shelter and as an investment, has been filled by borrowing — a liquidity boom akin to the historical cases I mentioned earlier.

Debt is a claim on future income. Borrowers monetize future income to buy houses today. Since that future income must therefore be dedicated to repaying debt, it can’t be used for consumption — buying goods. And that means that the consumption on which our future economic prosperity rests (58% of our GDP) is already spent. Our future spending is sustained only if we borrow more, such as by using our homes as bank accounts through home equity lines of credit.

As policy makers, we have a choice. We can continue to fuel this liquidity or we can gently let the pressure leak out. The stress test was designed to do exactly that… The mortgage stress test is exactly the kind of policy we need to protect our economy…

The potential consequences of our debt-fuelled real estate boom in Canada are serious. Asset bubbles fuelled by too much liquidity create the conditions for their own demise. When this money is borrowed and the investment value turns south, the vortex that the sudden withdrawal of that money creates a panic. Asset values crash until cooler heads prevail. Whether tulip bulbs in 17th Century Netherlands, the South Sea Bubble in 18th Century Britain, the 1920s stock market bubble, or early 21st Century US real estate, the pattern is foretold. Just ten years after such a crash, we have fallen into the “this time is different” trap of complacency.

We have a responsibility to prevent these tragedies. And while I’m not predicting, it nonetheless could happen here: of the 46 banking crises for which we have housing data, over two-thirds were preceded by real estate boom and bust cycles. Moreover, we must avoid policies that serve only to enrich the people who have already made tax-free gains on real estate; rather, we need to be deliberate to avoid further inflating house prices. Housing affordability is CMHC’s raison d’être and we will consistently argue for that…

Critics of the stress test ignore the fact that high house prices are the overwhelming reason why home ownership is out of reach. There are many economic and other factors behind this. In fact, the stress test has helped moderate house prices, making home ownership easier. If I can borrow an analogy from my colleague, OSFI Superintendent Jeremy Rudin: having braked hard enough to stop your car from barreling down a hill, you don’t declare victory and release the brakes…

Paul Taylor of the MPC was bold enough to criticize the FTHBI to this Committee last week in suggesting that we should actually encourage people to borrow 4.8 times income. This same rhetoric led successive US administrations to promote home ownership to a fault. Apparently, the MPC is content to see home builders, real estate agents and mortgage brokers receive short term benefits while Canadians bear the long-term costs.

My job is to advise you against this reckless myopia and protect our economy from potentially tragic consequences. Indeed, it was my primary aim in leaving a private sector career in finance for public service: to help prevent a repeat of the harm that excessive mortgage lending created for hundreds of thousands of households just a decade ago…

The stress test is doing what it is supposed to do. Please look past the plain self-interest of the CHBA, MPC and OREA and see house price moderation as helpful: an intended consequence. Choose instead to heed the consistent views of those of us who are unconflicted: the Department of Finance, OSFI, the Bank of Canada, the IMF — again just this week, and CMHC.

That’s how APRA should be acting. Not working hand in glove with the banking sector to pump out more mortgage debt to marginal borrowers.

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