The housing market has cooled, but many potential homeowners this might help are still stymied by the mortgage stress test, says Fergus Hodgson.
An uproar is brewing over real estate in Canada, fuelled by a misguided attempt to protect willing homebuyers from themselves. Owners see prices declining, while prospective first-time owners find themselves locked out by mandated stress tests.
The federal regulator should ease stress-test requirements – if not eliminate them altogether – before they cause further harm and curtail construction and broader economic activity.
A May 29 report, The False Binary: The Government Needs to Reframe Its Discussions about the Mortgage Stress Tests, reveals the painful impact. Will Dunning, chief economist at Mortgage Professionals Canada, estimates 100,000 Canadians, particularly millennials, have been unable to buy a house since the introduction of mortgage rules.
In January 2018, the Office of the Superintendent of Financial Institutions (OSFI) required federally-regulated lenders to test prospective borrowers’ ability to repay loans at an interest rate two per cent above the actual contracted rate. Even though a homebuyer might get a bank to lend him money at 3.5 per cent interest, he would have to qualify for a hypothetical 5.5 per cent loan.
The mandate is wrongheaded.
To be fair, though, the proponents sought to address what they perceived to be high default rates.
Merely raising the threshold for approval, however, does nothing to help those struggling with insufficient purchasing power and constrained housing supplies. It merely keeps them at arms length from the market.
Banks initially welcomed the rules, believing they could stabilize notoriously rocky and variable housing markets. As documented by the Frontier Centre’s International Housing Affordability Survey, Canada has both the least and most affordable homes in North America: Vancouver and Moncton, respectively. However, the impact appears to have been all one-way traffic. House prices have fallen.
An April research paper from the Bank of Canada found that resale activity in housing has dropped to 2015 levels, around 450,000 units per year. According to Dunning, in normal circumstances there would be 13 per cent – 65,000 – more resale units: “This shortfall can be interpreted as (to some degree) the continuing and substantial consequence of the stress tests.”
We’re already seeing the effects in the broader economy. On May 22, the Canadian Imperial Bank of Commerce (CIBC), the fifth-largest lender in the nation, declared it has no growth expectations for this year. CIBC’s quarterly report shows its shares dropped by four per cent and its net income by 2.4 per cent. Further, determined homebuyers often resort to alternative-mortgage lenders, which charge even higher rates and are not subject to the same federal regulations, adding risk to the financial system.
Benjamin Tal, CIBC deputy chief economist, released a report in April estimating the value of new mortgages in Canada had decreased by $25 billion or eight per cent in 2018. He attributed half of the decline to the stress tests.
Dunning argues the tests assume an unrealistic scenario and don’t take into account the future incomes of borrowers, which in many cases have a bright outlook. He calculated 18 per cent of prospective buyers, who could currently afford having their own homes, have failed the stress tests. Rather than scrap the requirement entirely, he recommends a lower benchmark of 0.75 percentage points above the contracted rate.
Real-estate boards and the Canadian Home Builders Association are also requesting urgent policy reforms. The real-estate sector, which made up one-fifth of the Canadian economy in 2017 and represented more than 75 per cent of Canadian wealth in 2018, contend their own downturn is, in effect, everyone’s downturn.
Dunning’s report shows housing construction has taken a notable hit: urban activity fell by 20 per cent in 2019’s first quarter compared to the average activity from 2013 to 2017, and rural activity fell by 15 per cent. Moreover, Dunning estimates 200,000 fewer jobs will be created in the next three years if the government keeps the stress tests.
“The economic impacts have barely begun, will develop slowly and won’t be fully experienced until the second half of 2021,” he warns.
However, Canadian authorities appear to be skeptical regarding the dampening impact of their regulations. While banks and other stakeholders lobby to reduce or withdraw stress tests from mortgage lending, the OSFI seeks to expand the policy to provincially administered loans. Even the International Monetary Fund shows naiveté and claims “a gradual slowdown in the housing market” is good news.
One could dismiss the criticisms as self-serving pleas from interest groups. On the other hand, regulators are far from dispassionate seekers of the common good: they grudgingly admit mistakes and only change policies under significant pressure.
Left unchecked, the fall in housing activity is fomenting the very economic hardship policy-makers are supposedly preventing.
Fergus Hodgson is the executive editor of Antigua Report, a columnist with the Epoch Times and a research associate with Frontier Centre for Public Policy. Daniel Duarte contributed to this article.