Bank of Canada Warns Policymakers Against Tinkering With Mortgages

The number two at Canada’s central bank just made it clear she isn’t a policy cheerleader, like the Governor has been in recent months. Bank of Canada (BoC) Deputy Governor Carolyn Rogers addressed finance professionals at the Economic Club of Canada last week, explaining the usual mortgage market risks. It got more interesting when she trekked into the rarely discussed issue of cheap credit and extended amortizations and how they actually erode affordability, even though politicians claim otherwise. The Deputy Governor warned policymakers that “there’s no free lunch,” and tinkering with the mortgage market can have the opposite impact while amplifying longer term risks to households, and the greater economy. 

Canadian Mortgage Debt Can Become An Expensive Problem For Taxpayers, Not Just Borrowers

One of Canada’s top bankers reiterated the risks the too-big-to-fail mortgage market presents. In Canada, mortgage debt is generally state-assisted and securitized (bundled and sold to investors), in theory helping to prevent a significant volume of junk loans. The process does however mean that when losses do occur, it can have a much bigger impact on market liquidity and financial stability.  

“Further, since mortgage insurance in Canada is backed by the federal government, large losses could have fiscal implications,” explained Rogers.  

She emphasized this is a risk the BoC is concerned about, but it’s a tail risk. The probability exists but it’s unlikely in the short-term. It’s more likely that other risks materialize first, such as manipulating short-term affordability at the expense of long-term stability.

BoC Governor Warns Excessive Cheap Credit & Leverage Can Worsen Affordability 

Rogers is the second deputy governor to explain that credit’s role in affordability is often misunderstood. In 2021, her predecessor Deputy Governor Gravel explained the past 30 years of low rates didn’t improve affordability but made it worse. As rates fell, buyers were more easily able to absorb price hikes. Rather than saving money on interest, households adjusted their payments and paid higher prices for homes. Great news for those who sell homes, but it means the prior 30 years of “affordability” improvements went the opposite way. A point the new Deputy also reminded households. 

“House prices are primarily a function of the balance between supply and demand. But since most people borrow to buy a house, prices are also affected by the cost and availability of housing credit,” explained Deputy Governor Rogers.

Adding, “The cost and availability of housing credit are, of course, influenced by central bank policy rates. They’re also influenced by government policy and regulations.

BoC Deputy Governor Warns Policymakers Against Tinkering With Mortgages 

Until recently, the BoC had been tightening credit availability through rate hikes and quantitative tightening. It had a significant impact in other segments, but limited success when it came to home prices. This was largely due to the government policy and regulations that Rogers mentions above, which have undermined monetary policy via fiscal policy.

Similar to former Deputy Gravel’s point, Rogers suggests “there’s no free lunch. Steps to reduce the short-term cost of mortgages for borrowers can increase their long-term costs.” 

One example of policy seeking short-term gains is the amortization extensions. According to the bank’s calculations, the average borrower can shave $200/month off their mortgage payments by extending the amortization from 25 to 30 years. However, she warns this will result in the borrower paying an extra $50,000 in interest over the period. 

A point many may not appreciate, but it would be like the average worker losing a year of income after taxes. That doesn’t just suck for the borrower who goes to work for a whole year just to cover the interest, but it’s also funds diverted from productive consumption, placing a drag on the general economy. 

“… we need to resist the temptation to try to solve the housing affordability challenge by tinkering too much with the mortgage market,” she warns. 

The banker then went on to explain it’s “encouraging” to see policymakers embracing solutions. Though once again, reiterated that short-term bumps may help briefly, but undermines the progress towards a sustainable market with higher costs over the long-term—for both borrowers and the general economy. 

”Ultimately, though, improved housing affordability requires a better balance between supply and demand, and achieving this balance will take time,” explains Rogers. 

Concluding the right balance is important and suggests, “In the meantime, leaning too much on measures that reduce the short-term cost of financing could have long-term impacts on the financial health of households, the mortgage market and the economy.”