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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