Canada’s mortgage stress test must be maintained because it is helping prevent a potential financial crisis from a “debt-fuelled real estate boom," the head of the national housing agency said Thursday.
In a letter to the House of Commons finance committee, Evan Siddall, chief executive of Canada Mortgage and Housing Corp., offered an aggressive defence of the controversial mortgage qualification standard, saying it is needed to forestall potentially devastating economic consequences if house prices and debt levels rise even further.
“The mortgage stress test is exactly the kind of policy we need to protect our economy,” Mr. Siddall said.
He said the consequences of Canada’s “debt-fuelled real estate boom” are serious and collapses of asset bubbles have historically created panic. He drew comparisons to the tulip bulb crisis in the Netherlands in the 17th century, the stock-market bubble of the 1920s and the collapse of the real estate bubble in the United States in 2009.
“Just 10 years after such a crash, we have fallen into the ‘this time is different’ trap of complacency,” he warned. “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.”
He accused real estate industry groups such as Mortgage Professionals Canada (MPC) of proposing changes to the stress test that would drive up home prices in major cities while stimulating more borrowing by Canadians who are already deeply indebted.
“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,” Mr. Siddall said.
“My job is to advise you against this reckless myopia and protect our economy from potentially tragic consequences.”
Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), introduced a stress test on uninsured mortgages – those with a down payment of 20 per cent or more – in January, 2018, to curb risky lending practices, bringing such mortgages more in line with those of buyers putting down less than 20 per cent. The stress-test rule requires borrowers to prove they could still afford their mortgages even if interest rates were two percentage points higher than the rate they negotiated with their banks, providing an affordability cushion if rates were to rise.
The policy has been a lightning rod for groups in the real estate sector, who argue it is too harsh and is contributing to a steep decline in home sales because first-time buyers cannot qualify for mortgages.
Mr. Siddall sent his letter Thursday to the finance committee because it has been hearing submissions from industry groups urging it to moderate the test. He said he had hoped to address the committee personally, but was unable to arrange a date.
Since the start of 2018, home sales have fallen sharply, dropping 11 per cent nationally last year. Sales declined the most in Canada’s two most expensive cities – 32 per cent in the Vancouver region and 16 per cent in the Greater Toronto Area – in 2018. In the first quarter of 2019, national sales fell a further 4.1 per cent.
MPC CEO Paul Taylor said Thursday that his group has never recommended eliminating the stress test, only reducing it. He said it is “incredibly frustrating” that the people at the bottom end of the economic ladder have faced a 20-per-cent reduction in buying power because of the stress test, while wealthier people remain unaffected and have also seen home prices drop in some major markets, making it even easier for them to buy.
He said mortgage brokers are not “bogeymen that are forcing people into loans they cannot afford" and are not urging reforms because they want to make more money, but are on the front lines talking directly with the most disappointed consumers.
“Trying to suggest that folks that I represent, who are customer service professionals, are doing anything untoward, or outside of the wishes of the consumers they serve, is frankly misguided,” he said.
While real estate groups have complained that the stress test is having unintended consequences and is keeping would-be buyers out of the market, Mr. Siddall said in his letter that the consequences are not unintended and that the policy is working as anticipated.
“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,” he said.
He also dismissed industry suggestions that it is safer now for the government to adjust the stress test because interest rates have risen since it was first implemented, reducing the risk of a major rate shock.
He said the main goal of the stress test is not to protect against interest-rate increases but to ensure Canadians can afford their mortgages if they face personal financial stresses.
“The single largest risk to an insured mortgage is the homeowner’s unemployment – not higher interest rates,” he said. “Our objective is to protect economic growth and jobs.”
He also offered a warning about the growing level of household debt in Canada, saying it is going to affect future spending if borrowers must dedicate more money to repaying their loans. Household debt has climbed from 106 per cent of disposable income in 1998 to 178 per cent at the end of 2018, he said, which puts future economic growth at risk.
While the federal government announced a new first-time home buyers program in its March budget this year, which will provide $1.25-billion in interest-free loans over three years, Mr. Siddall said its modest scale will have “a near insignificant impact on prices.”
By comparison, he complained that proposals from the Canadian Home Builders’ Association, MPC and the Ontario Real Estate Association – which have called on the government to ease the stress test and allow insured mortgages to be amortized over 30 years instead of the current 25-year maximum – would broadly add to housing demand across the board.
CMHC estimates such a move would lead to home price inflation of as much as 2 per cent in large cities, Mr. Siddall said.
Kevin Lee, CEO of the Canadian Home Builders’ Association, said Thursday that such price inflation would not be unreasonable over a year or two, while tens of thousands of new first-time buyers could qualify for homes if current lending rules were reformed.
“Conversely, if you lock all of these tens of thousands of home buyers out, and house prices drop a little bit but nobody can afford a home, you just have less equity and less people to buy a home, but you haven’t achieved affordability," Mr. Lee said.
He said home builders’ main concern is to ensure home prices stay affordable and consumers do not take on excessive debt. But with more than 60 housing finance regulatory changes introduced since 2009, he said policy-makers “have probably overshot their mark at this point, and it’s time to tweak and adjust them.”
The OSFI has repeatedly said it is monitoring the impact of the B-20 stress-test rule on the Canadian housing market, but has not offered any signal it could relax the measure.
“Based on our observations, the B-20 revisions are having the desired effect of helping to keep Canada’s financial system strong and resilient,” spokesman Gilbert Le Gras said Thursday in an e-mailed statement.