Should the federal government intervene further in the housing market?

With home prices continuing to climb in most markets in Canada, the Federal Ministry of Finance and the Office of the Superintendent of Financial Institutions (OSFI) are under increasing pressure to introduce yet another round of mortgage rule tightening to try and put a damper on this bubble-like price inflation.

The most recent of these interventions had three components: reduction of the maximum amortization period of 25 years for mortgages to quality for CMHC mortgage insurance; no insuring of mortgages for homes valued at more than $1 million; and a reduction in how much people can borrow against their home in the form of a second mortgage. These changes came into effect in July 2012. While they had the desired effect of gradually bringing down the very frothy Vancouver housing market, this was unfortunately not repeated in most of Canada’s other cities. These markets barely noticed, with most sales volumes and prices continuing to climb unabated.

Despite mortgage rates rising by as much as three-quarters of a percentage point between May and September (they have come back down close to 0.2% over the past month and a half), house prices continue to rise in most markets. By the end of 2013, CMHC is projecting that for Canada as a whole, home prices will have climbed 4.0%. Yet growth in the number of sales of existing homes has been steadily levelling off, and should end up about 0.5% higher in 2013 than in 2012.

The Bank of Canada

Since the principal (some would say only) mandate of the Bank of Canada is to control inflation, which is firmly in check, there is no compelling reason for the central bank to increase its benchmark lending rate, which has been frozen at 1.0% for more than three years. While raising it would cool the housing markets, given the insignificant effect of rising mortgage rates over the summer, the amount that the Bank would have to raise its rate in order to have the desired effect on home prices would probably have a much greater and harmful effect on an already fragile economy.

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One of the only changes that the Finance Minister and OSFI can invoke at this stage (they have tried everything else over the past four years) would be to increase the minimum percentage of down payment that a buyer must make in order to qualify for CMHC mortgage insurance. Currently this is 5%. Yet even a modest increase (say to 8%) could shut a huge number of first-time homebuyers out of the market. This would hit the home construction sector particularly hard, since a lot of new homes being built now are starter homes. Perhaps this is necessary collateral damage, in order to ensure a soft landing for broader housing markets across this country.

Lessons from Norway

Interestingly, Norway recently increased its minimum down payment to a whopping 15%. It had little choice, given the huge bubble it was facing. Home prices there have increased more than 30 per cent since 2009. But in the two months since the rule change came into effect, home prices have fallen far more than predicted or desired. Some economists are predicting they will fall 15-20 per cent over the next two years, which could in fact force the Norwegian central bank to actually cut lending rates further. It looks like Norway is heading for anything but a soft landing.

Yet outside of the enormous Greater Toronto condo market, where sales of new condos have dropped more than 27 per cent year-over-year, the inventory of unsold condo units has climbed to greater than 27,000, there are more than 300 condo projects under construction and prices are beginning to decline. Housing markets in nearly every market in Canada are looking dangerously frothy. Given that the Bank of Canada has clearly signalled that its rate will remain steady for the near future and mortgage rates seem unlikely to rise much in 2014, perhaps the time has come for the federal government to take the next step and bump up the minimum required down payment. But this should happen in small increments, while carefully and patiently measuring the effects, lest the Norwegian experiment be repeated.