Speaking Notes for Evan Siddall, President and Chief Executive Officer, Canada Mortgage and Housing Corporation
Bank of England Office
Check against delivery
This is a welcome moment for me today personally and professionally. As a friend in New York many years ago, the Governor, who remains a friend today, has long since opened my eyes to a more rewarding career in public service. He helped me see past a mercenary existence amid the trees to a far more fulfilling career attending to the forest. Today is, in a way, an opportunity to thank him for that.
I want to talk to you today about the state of the Canadian housing markets and the use of macro-prudential tools to promote economic growth. I would like to make the case for Canada’s ongoing progress in this area, and suggest that the strength of our financial system and economy are evidence of it.
The Governor and I are both Canadians. We come from a country that emerged from a fragile peace between English and French. Two solitudes originally, we formed a crucible that attracted people from around the world to a place of openness, tolerance and inclusion. Canada is therefore quite naturally an open market, where trading, investment and people from around the world are welcome.
Relatedly, it is notable in a discussion of macro-prudential mechanisms that Canada was the first major country in the world to exit the gold standard and to float its currency. The Canadian dollar has floated for 60 out of the past 66 years. In fact, no other major country has had as much experience with a floating exchange rate.1 The rebalancing effect of a floating exchange rate has been found to be among the most powerful macro-prudential tools. It keeps policy makers honest and prices differential economic prospects and risks among economies. Few – and possibly no – macro-prudential policies are as effective as unpegged currencies.2 This is Canada’s point of departure in automatic adjustment mechanisms.
Housing Market Vulnerabilities in Canada
Before turning to the specifics of macro-prudential policy in Canada, I should provide a brief overview of the vulnerabilities associated with the housing markets that were instrumental in the most recent macro-prudential changes and that continue to influence our policy thinking.
Concerns about elevated house prices in Vancouver and Toronto are well-known in Canada. CMHC has recently observed spillover effects from Vancouver and Toronto into nearby markets.
Growth in National Average MLS® Price is Driven by Vancouver and Toronto
MLS® Average House Prices in Canada — Seasonally Adjusted
Source: CREA (Last data point 2016 Q2)
These factors were reflected in our Housing Market Assessment, released on October 26. They caused us to issue a “red” warning for the first time concerning the Canadian housing market as a whole.
CMHC Housing Market Assessment: Emerging Evidence of Problematic Conditions
|Nov. 2014||Apr. 2015||Aug. 2015||Oct. 2015||2016 Q1||2016 Q2||2016 Q3||2016 Q4|
|Victoria||Not reported||Not reported||Weak||Weak||Weak||Weak||Weak||Weak|
|Hamilton||Not reported||Not reported||Weak||Weak||Weak||Weak||Moderate||Strong|
|Moncton||Not reported||Not reported||Weak||Weak||Weak||Weak||Weak||Weak|
|St. John’s||Not reported||Weak||Weak||Weak||Weak||Weak||Weak||Weak|
Worse, the level of household indebtedness in Canada has reached an all-time high and now sits at 168 per cent of income. The Bank of Canada has named this factor the greatest vulnerability to our economy and highlighted growing debt levels among the most vulnerable homeowners as a particular cause for concern. This includes many first-time homebuyers with less job tenure and higher demands on their pocket books.
The Household Debt-to-Income Ratio in Canada is Above U.K. and U.S. Levels
Household Debt-to-Personal Disposable Income Ratios
Source: OECD. Last observation: Canada, U.S. and Australia: 2014, U.K.: 2015.
Less liquid housing investments – compared to other assets – are also hovering near historic highs as a percentage of household net worth, threatening to compound the pro-cyclical effects of house price corrections.
Higher Concentration of Net Worth in Less Liquid Real Estate Assets Suggests an Additional Source of Household Vulnerability in Canada
Source: Statistics Canada and calculations from CMHC
Last data point: 2016 Q2
These conditions were begging for a policy response. High levels of indebtedness coupled with elevated house prices are commonly followed by economic contractions. In their book House of Debt, Atif Mian and Amir Sufi called the relationship“ so robust as to be as close to an empirical law as it gets in macroeconomics.”3 The conditions that we now observe in Canada concern us. Increased household borrowing could be jeopardizing our economic future.
Whither Macro-prudential Policy?
It matters to house prices that interest rates are low, of course, providing extraordinary stimulus in a moribund economic environment. Accommodative monetary policy aggravates the vulnerabilities that already exist relative to house price growth and highly-indebted households.
Increasing rates to counteract these effects is too blunt an instrument for addressing specific pockets of imbalance and vulnerability.4 The International Monetary Fund has concluded that the cost of using monetary policy to “lean against the wind” outweighs the benefits in all but the most exceptional circumstances.5 Indeed, macro-prudential tools complement monetary policy by dulling its effect on housing imbalances where it could jeopardize the ultimate goal: economic growth.
And growth must be the objective. My assertion might be obvious, but I think it’s often overlooked. Macro-prudential policy should aim to promote economic growth, not to save banks from themselves, necessarily. Nor is macro-prudential policy a vehicle to manage the business cycle as such. In the end, policy makers must design programs that support the long-term, sustainable growth of the economy. This objective should cause us to focus macro-prudential policy to best target growth.
Macro-prudential Policy in Canada
Returning to Canada, our micro-prudential regime is the responsibility of the Office of the Superintendent of Financial Institutions. OSFI has itself introduced important prudential measures to target elevated household risks. These include, for example, residential mortgage underwriting standards for regulated lenders and mortgage insurers. OSFI has also recently introduced more risk-sensitive capital rules for mortgage insurers, including CMHC. The capital rules for our banks have been further amended regarding exposure to residential mortgages. These are necessary micro-prudential requirements that we have supplemented in Canada via macro-prudential actions.
Canada was an early adopter of a macro-prudential regime, with the introduction of mandatory mortgage insurance 60 years ago, which today is required where a homebuyer has less than a 20 per cent down payment. Mortgage insurance benefits from a federal government guarantee of 100 per cent for CMHC and 90 per cent for our private competitors.
By virtue of its role in guaranteeing mandatory mortgage insurance, the government assumes responsibility to ensure that the programs support a healthy and growing economy. As such, the so-called “sandbox” rules governing mortgage loan insurance have been tightened six times since 2008 in order to manage housing market vulnerabilities. These have applied both to the mandatory homeowner insurance on mortgages above loan-to-value ratios of 80 per cent and also to a voluntary program through which lenders can buy bulk portfolio insurance on low-ratio mortgages. They do this to access CMHC’s securitization programs, which are only available for insured loans.
These sandbox measures have effectively applied macro-prudential limits to insured mortgages, including: reduced allowable amortization periods; specified minimum down payment requirements and debt service maximums; limited mortgage refinancing; a price cap of $C1 million; and required interest rate buffers, or “stress tests,” to be used in underwriting.
Most recently, on October 3rd, Canada’s Minister of Finance announced a new round of tightening of these eligibility rules for insured mortgages. In addition to some tax measures, a “stress test” was introduced for all insured mortgages: the Bank of Canada posted rate (about 2 per cent higher than the contract rates at the time of the announcement) must now be used to underwrite all guaranteed mortgages rather than contract rates. This interest rate buffer will specifically help offset the highly stimulative effect of low interest rates. Secondly, while lenders are free to offer more flexible terms for uninsured mortgages, government-backed mortgage insurance will no longer be available for any mortgages, high- or low-ratio, on properties valued above $C1 million, nor those with amortizations beyond 25 years.