Canada

Canada Tried To Stop Real Estate Prices From Falling, And Created A Bigger Bubble

Last March, the Canadian government sprung into action when news of a pandemic struck. No, not for PPE as you might guess. An email shows they rejected an offer from a major N95 supplier, stating “masks are not a priority.” If healthcare wasn’t the government’s top priority, what was? Preserving real estate prices, it would seem. Here’s a brief list of measures taken that contributed to supersized home price growth.

Bank of Canada Cuts Interest Rates 3x

The most obvious contributor to the overheated real estate market is interest rates. The Bank of Canada (BoC) made not one cut, not two cuts, but three cuts to the overnight rate in less than a month. The overnight rate was 1.75% on March 4, 2020 and received a 50 bps cut on March 4. It was followed by another on March 16, with a third on March 27, 2020. The rate is now 0.25%, effectively making interest rates negative in real terms.  

This is one of those cases where it appears panic ruled over actual data. According to the BoC, it takes “between six and eight quarters” (18 to 24 months) to feel the full impact of a rate change. They may have had an argument as to why they did it (Fed needed debt, currency), but it still resulted in unexpected consequences.

They also made repeated cuts before they had a full assessment of the issue. Doing this always runs the risk of adding too much stimulus. Not surprising, since the general rule is to err on greater social inequality, than to err on lost profits.

Canada Eased The Mortgage Buyer “Stress Test”

The BoC also lowered the five year conventional mortgage rate, which is used for the stress test. The rate was 5.19% on March 11, 2020, and received three cuts along the way until it hit 4.79% on August 12, 2020. This added an additional ~4.5% in qualified buying power. The stress test only applies to OSFI-regulated lenders, but they’re the majority of activity.

The implementation of the stress test was bad to begin with, and should have been more responsive. Non-OSFI regulated lenders aren’t required to stress test. In fact, many lenders (including credit unions) qualify at the contract rate. Banks are also allowed to exempt a certain percent of borrowers, as long as they manage the risk properly.

It was pretty useless in my opinion, but even so the timing of the cuts added fuel. Credit is supposed to tighten during a downturn, not loosen. If access to credit is expanded beyond relief during a downturn, it’s a prioritization of the economy over borrowers.

The Bank of Canada (BOC) Bought Billions In Mortgage Bonds

In January 2019, the BoC began to add Canada Mortgage Bonds (CMBs) to their balance sheet. The move was similar to the one the US Federal Reserve made in 2009, to stimulate home price growth after the crash. The BoC assured people this was just a routine operation. They would only be buying it on a non-competitive basis. At the time, it was questioned if they were putting in place a mechanism for quantitative ease (QE) when needed.

Fast forward to March 2020, and the BoC announces a program to begin buying CMBs on a competitive basis. The central bank began actively competing with investors, to drive rates lower. A QE program was born, and it already had mortgage tools. Neat coincidence.

The program only existed for a few months, before being discontinued in October 2020. By December 2020, they held $9.66 billion worth of CMBs, an 1,803% increase from a year before. This move suppressed yields, and injected billions in liquidity into the system. It’s not the size of the program, but the amount of excess it provides that matters. In this case, a sh*t ton. 

Banks Didn’t Have To Put Aside Money For Mortgage Deferrals 

Last March, Canada did what many countries did – rolled out mortgage payment deferrals. Unlike other places, Canada didn’t require a reason for a payment deferral. It was just a break from paying your bills, and an interest free loan. CBA statistics show 16.7% of mortgages at member banks granted payment deferrals. That’s one in six mortgages held by member banks. The rate of deferrals was even higher than the peak unemployment rate.

No, this isn’t about granting people payment deferrals. Banks aren’t supervillains. They always try to grant mortgage payment deferrals for people that need them. Typically they have to put aside capital for the mortgages they defer, as a safety measure. Regulators allowed banks to skip that during special treatment. Consequently, they handed them out like candy, and got a liquidity injection. Can you see a trend here?

Canada More Than Doubled Lost Income 

The Canada Emergency Response Benefit (CERB) was a popular program with everyone. The amount chosen, and the lack of targeting, was a little odd though. The government ended up replacing the lost income with almost 3x the amount of income lost. Even the partners of politicians took the government up on the offer, despite not exactly facing hardship.

The result of handing cash to people that didn’t need it, is an elevated savings rate. Economists have stated they expect this to help push real estate sales further. Future expectations play a large part in setting current behavior. This added gas to FOMO-driven real estate markets.

Banks Get A $300 Billion Injection of Credit Liquidity

The domestic stability buffers are extra cash the largest local banks have to put aside. In December 2019 Domestic Systemically Important Banks (D-SIBs), were told to raise buffers. In a note from OSFI, the banks were notified to raise the buffers from 1.0% of risk-weighted assets, to 2.25%. This was to go into effect on April 30, 2020, giving them a few months.

The reason was “key vulnerabilities … remain elevated, and in some cases show signs of increasing.” They further add a list of vulnerabilities, which “includes Canadian household indebtedness” and asset imbalances. At the time, they were worried households held too much credit, largely mortgages. 

Banks can’t just scale up the capital they reserve by one point all at once – they need time to do it. That means by March, they would have largely put aside most of the cash needed for the buffer. On March 13, 2020, OSFI announced they were reversing the measure.

This injected $300 billion of cash into … what’s that? You know this one? That’s right, liquidity. All of a sudden household vulnerabilities didn’t matter. It was more important to issue credit as quickly as possible, which was largely mortgages.

The US has a similar set of rules in place to increase bank liquidity, but on a timeline. The rules are set to expire on March 31, 2021, with senators fighting to make sure they expire. The lack of liquidity is no longer the threat. Too much liquidity is now the issue they’re trying to tackle. Canada isn’t even having this discussion yet.

This Was Far From A Comprehensive List

Now, this was just a short-list of some of the measures that impacted home prices over the past year. This isn’t a criticism of whether these were the right or wrong moves, just a partial list of price influences. That said, front-loading stimulus for real estate is generally a really bad idea.

When you do that, you aren’t just trying to forecast when a real estate price will happen. You’re trying to forecast when home prices will crash, then trying to stop it. Figuring out how much home prices will fall is a hard enough task. Add trying to figure out how much cash you need to lend people to prevent it, makes it impossible. 

In March, the government thought the world was going to end… at least for real estate. The BoC was expecting arrears to rise over 300%. The CMHC was expecting real estate prices to drop 11% on average. The government planned their response with the same data, and tried to prevent it. 

When the world didn’t end, they had already delivered a “response” to fix it. The average home price didn’t drop by 11%, like they thought. It only fell *checks notes* oh, it increased by 23.5% over the past year. If you think the CMHC forecast was bad, you should ask the Fed how they determined the amount of stimulus needed.

Now, let’s circle back. This isn’t a comprehensive list of measures that impact prices, but it’s a lot of them. By the end of March, they had started cutting interest rates, reducing stress test rates, buying mortgage bonds, giving payment deferrals, replacing income in excess of wages lost, and injected hundreds of billions into credit liquidity at just the big banks. A couple months later, Canada suggested maybe wear a mask

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35 Comments

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  • Adam J 8 months ago

    I mean, it’s kind of funny if you already own.

    • OT 8 months ago

      As long as you don’t need to upgrade or anything, because selling a house in the city results in almost nothing across the province.

      • Greedy 8 months ago

        And so long as you don’t have any kids, friends, or other loved ones wanting to buy and enter the market.

  • Trader Jim 8 months ago

    Governments think they’re more efficient than the market, and always inject too much into it, then need restrictive measures.

    They should learn from this, but there’s no way they’ve even taken a basic assessment like this post, before designing the next set of measures to restrict activity.

    • Whiskey Foxtrot 8 months ago

      What did Stephen write on Twitter the other day? “Politicians should be required to read the old lady who swallowed a fly” or something. ☠️

  • Liam 8 months ago

    Federal foreign buyer tax coming. Giddy up.

    • Whiskey Foxtrot 8 months ago

      Nah. I mean, it’s probably coming, but it won’t fix it. Foreign buyers are selling, and locals were just given enough liquidity to absorb it.

      • Paul 8 months ago

        Exactly,
        Hot money moves. It’s already been sunk in somewhere else. There is a phrase “fry it up” and then you sell out. If this is the top there isn’t any “value” left and they will wait for the bottom where most likely the govt will remove any measures they put in place. It’s going to be one hell of a ride but probably ok for anyone who has been sitting on their hands.

    • Ahmed 8 months ago

      So many exemptions, a foreign buyer tax isn’t useful. We don’t even do criminal record checks if you’ve been watching Cullen.

      That’s aside from whether or not there’s a valid issue with foreign buying FWIW.

      • Interesting Times 8 months ago

        Given there isn’t enough supply for locals, it’s an issue if it’s being purchased by foreigners.

        I think the govt should implement restrictions on ownership akin to New Zealand and other countries. Maybe if you pay taxes (as this would include some foreigners) or similar.

        Also if they’d implement a stepped system on property tax for multiple properties.

    • SH 8 months ago

      Considering the current government consistently puts foreign speculators ahead of Canadian workers, you can bet that any such tax will be toothless.

  • Jason Chau 8 months ago

    The Matrix is offering us the inflation pill or the home price pill. Choose one.

    • Dee 8 months ago

      It is as if the government thinks that money is worthless. How is someone makes a salary of $60k supposed to live? Money & time to earn money is truly worthless when such a large portion of society is indiscriminate with money

    • Erik 8 months ago

      Cheap real estate on the Mars mission

    • Old Greg 8 months ago

      Inflation is inbound which is to say your home prices will climb as your dollar tanks, at which point inflation will need to be cooled and how do we do this, higher interest rates… Once the rates start going up home prices, well I think it’s obvious they will take a wee bit of a nose dive. This is 50 x worse than 2008 in my opinion.

      • Bob 8 months ago

        Totally. I laugh at the notion of “taking advantage of low interest rates”…. It’s only an advantage in a relatively stable Home Price Index; Low interest rates on insanely overvalued properties is the equivalent of super high interest rates on lower house prices. What are all these over-stretched borrowers going to do when their huge mortgages are subject to even moderate interest hikes? Redundant question.

  • straw walker 8 months ago

    It’s a fact
    every time the government tries to make it easier for home ownership, it just pushes up house prices.
    It’s like a dog trying to catch it’s tail
    Lower rates..up goes the house prices
    Lower qualifying standards, up goes house prices.
    But from all of this.. those that want to own and live in a house to raise a family, never quite get there.
    They are left out in the cold while , speculators and foreign investors, buy up Canada.

    • Mortgage Jesus 8 months ago

      The government knows what it’s doing. It extends credit for “affordability,” coincidentally making their donors wealthier.

      Imagine if they did that with food? “To stop food prices from rising, we’re going to let you pay over the next 25 years. If they rise again, we’ll give you more money.”

  • Keshav Rangachari 8 months ago

    One of the most comprehensive presentation and analysis on today’s state of affairs by Stephen. Thank you. This covers what happened and I request that his next article be what is the impact of these government actions ? Why is this good or bad for society? What are the impacts long term? Is government and most people too deeply invested in this free credit ecosystem that there is potentially no turning back? Has government pushed itself to the corner?

    • Ian Brown 8 months ago

      I think it’s pretty obvious it’s good for society if a whole generation is seeing home prices faster than they could make as a household.

  • SH 8 months ago

    I believe the CMHC’s now infamous 18% correction was a kind of false flag concocted by the federal Liberals to give them an excuse to rig the bond market and bail out insolvent mortgage borrowers.

    • Ian Brown 8 months ago

      The CMHC’s forecast is based on pre-stimulus data. It may have been overly bearish, but I think the point of the article is everyone in government though this was the Great Depression.

      Even today, when we know things aren’t that bad, I still hear journalists compare it to the Great Depression for some reason.

      • Erik 8 months ago

        Dude, 20 percent unemployment since March. It’s worse then the depression. The difference is that the govt injected cash and liquidity to prevent a collapse whereas in the depression, govt’s tightened their belt and let the correction happen…

      • Tom Wolfe 8 months ago

        The naivety of this statement leaves me speechless. Our economy is utterly decimated. That it may not be headline doesn’t make it less true. A person need only look out their window, or think.

      • Bob 8 months ago

        We know things aren’t that bad? What the hell are you talking about? Our unemployment rate is DOUBLE that of the average amongst G7 nations.

  • Jimmy 8 months ago

    CMHC was most likely conservative if no measures were taken.

    I’m glad that some out there find what is going on funny.

    Our serendipitous good fortune is flushed town the toilet by the minute.

    Put canadian balance sheet into Google. If you still think this situation is funny you must plan on moving or don’t live in Canada.

    Awesome your house price went up but our balance sheet is quickly closing in on 50 percent of our economy.

    Merry Christmas! Good luck at the grocery store.

    Watch what happens to our country when people can longer afford to eat

  • The Smoking Man 8 months ago

    I have noticed that Teranet is expunging historical house sales and transfer dates. Does this have anything to do with the new reporting guidelines effective December 2020?

    For example, Oakville/Bronte houses that were built in 2004, sold at low $400Ks, have flipped several times and are now selling for almost $2M but they have no sales history on Teranet.

    How can this be? More importantly is why? Who is benefitting by the change?

    • Erik 8 months ago

      Criminals, politicians and real estate industry benefit from non disclosure.. easier to convince people these prices are reasonable and rational…

    • Paul 8 months ago

      The Smoking Man,

      Most likely the same reason why TREB won’t post sales data even though they have been told to make it public. When the house of cards comes down records show that they knew what was happening and didn’t do anything about it. Instead they decided to ride the money train.

      If media had access to data in full you can bet that they would be writing articles and a different narrative would be emerging right now. There is a lot industry people who know how this happened pretending they are in the dark.

      So far the only people who actually know what’s happening have to put together their hypothesis from available data which pundits can say was manipulated or contrived. It’s all very convenient.

  • Aemar 8 months ago

    Interesting.. makes a lot of sense… There should be an action lawsuit against market manipulation.. all the government ever did is pile debts on homeowners instead of addressing the real issue!!!! Stop home speculation!

  • CanadaSteve 8 months ago

    What if you’re one of the lucky ones who had no mortgage yet happened to have the perfect property people fleeing the city want right now and I’ve cashed out over the last year with a huge return?

    Sitting outside market,with a ~$1mill of cash at age 41 no debt, no kids, what would you recommend we do?

    I’m thinking of sitting outside and waiting for it all to correct\crash and then buy back in.

  • Old Greg 8 months ago

    Check out Canada’s balance sheet on Trading Economic’s, bye bye dollar and yeah home prices… You see most are to dumbed down to realize that the home prices aren’t actually going up it’s your dollar losing purchasing power.. What I believe is happening is savvy investors are selling there urban city homes and rolling the profits into undervalued smaller city’s primarily on the East coast and driving the home prices up there. This is not by any means good for the local populations as it’s going to make living much much more expensive, this is of course until we see interest rates spike to attempt to cool inflation.. My money is on stagflation, rising prices in goods and food meanwhile home prices tank, I am 100% playing the hedge game at the moment all in on commodities, Gold, Silver and Platinum..

    • Tom Wolfe 8 months ago

      I remember seeing Volkswagen Beetles for sale in Mexico with window stickers stating the cars cost $2,300,000. Then the cut the peso by like a 1000? Is this coming to Canada?

  • The Truth Shall Set You Free 8 months ago

    The Federal government extended CRB as well as Wage and Rent Subsidies. If they don’t extend again how high will unemployment climb in the third quarter and how many small to midsize companies (and some large) do under creating a financial crisis not seen ever. This is akin to a person choosing to not seek medical attention when their finger falls off and instead using bandaids or electrical tape to hold it in place thinking it will heal on it’s own. By the time they do seek medical attention as they realize something is wrong it’s too late as fasciitis has set in and instead of only losing the finger they now have to have many appendages cut off to live. Loss of quality in order to have the quantity (although significantly reduced).

  • Epargne Québec 8 months ago

    The housing market in Canada is going totally mad… I live in Greater Vancouver, and you cannot afford a flat in the city center for less than 1 million $… The truth is that we are living in an economy based on debt – both public and private – and bubbles are growing everywhere. It’s been a decade we’ve been thinking that central banks have magic sticks with which they create money. But sooner or later there’ll be an adjustment to the reality, and when that comes we’ll face the same troubles as in 2007. The human being does not learn about the past, it seems…

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