Starting in 2008, the federal government has made changes to the manner in which mortgages can be financed through the Canada Mortgage and Housing Corporation (CMHC). For instance, the maximum amortization period has been reduced from 40 years to 25 years; the maximum gross debt service ratio is 39 percent and the maximum total debt service ratio is 44 percent. Until February, 2016, homebuyers needed to have a 5 percent down payment. Starting February 15, 2016, this has now been increased to 10 percent for any amount between $500,000 and $999,999. (Homes that are worth more than $1,000,000 require 20 percent down payment, so CMHC is not involved.)
The changes instituted in February of this year are aimed specifically at the Toronto and Vancouver housing markets. When announcing these changes, Finance Minister Bill Morneau stated, “We are not fearing anything in particular, what we are doing is trying make sure we look at areas of the market that present potential risks”. Although unwilling to say it specifically, Mr. Morneau appears to be fearful of a housing bubble in the Toronto and Vancouver markets.
The problem here is that, if indeed there is a risk of a housing bubble, federal government policy was a large contributor to the creation of this bubble. The extremely low interest rate policy that began in 2008 is designed to get consumers and businesses to save less and spend more. In response to the incentives put in place by this low interest rate policy, consumers have chosen to spend more on housing. In cities such as Toronto and Vancouver there is strong demand and restricted supply of detached housing, combined with an inflow of foreign buyers, which serves to increase house prices. Clearly, the low interest rate policy began to exacerbate this increase in prices.
This is where the federal government is running into the problem that is almost always associated with policy implementation: no matter how honorable the original intentions of any particular policy may have been, there will almost always be what is politely termed unintended consequences. In the case of low interest rate policy, the unintended consequence may be a housing bubble in localized markets. In response to the unintended consequence of housing bubbles, the government introduced new policy in the form of mortgage rule changes that apply across the entire country. Introduction of this new policy produces its own set of unintended consequences.
Until the recent decrease in the world price of oil, growth in Alberta largely drove the growth in the Canadian economy. Today, with the price of oil stubbornly hovering in the $30 U.S. range, the Alberta economy is slumping quite badly. Because of the February, 2016 mortgage rule changes, an already underperforming Alberta housing market will likely be adversely affected. These changes will depress demand for housing in Alberta, making the already depressed housing market even worse.
The policy lessons to be learned from these mortgage rule changes are quite clear. Before implementing any policy, governments must think carefully about the consequences, both intended and unintended, that may arise in the implementation of these policies. Failure to do so may lead to the seemingly never ending implementation of a new policy, which is simply designed to correct the unintended consequences of some previous policy. This type of knee jerk policy implementation is not good for the overall economic performance of an economy and should be avoided.
Frank Atkins is Research Chair of Finance & Capital Markets and Brianna Heinrichs is an executive assistant at the Frontier Centre for Public Policy.