Relax, everything’s fine. Or maybe it’s not. The Bank of Canada (BoC) quietly made plans to buy government backed mortgage bonds, last week. The move is designed to increase the bank’s assets, and arguably assist the housing market. That sounds great, until you realize how these things work. It’s a similar set-up to the one the US Federal Reserve created ten years ago.
Central Bank Balance Sheets 101
The BoC balance sheet is like any other, filled with assets and liabilities. Assets are anything they pay for, usually Government of Canada bonds. Liabilities are anything they give out, like that roll of loonies you picked up for laundry, or the deposits in your bank account. When a central bank buys assets, they do it by crediting the account of the seller, usually with money that didn’t exist before. The cool monetary policy kids call that a “print,” and they are strategic for inflation.
Editor’s Note: There are no cool monetary policy kids.
Central banks buy assets to increase the money supply, since a print is usually required. This is strategic, used with interest rates, to maintain inflation at target. Sometimes a central bank can’t find enough assets to buy, or needs to provide market liquidity. In this event, they’ll expand their mandate or the types of assets they intend to acquire. The BoC is basically announcing both.
The Bank of Canada Will Buy Canada Mortgage Bonds
The BoC announced plans to buy government guaranteed debt issued by Crown corporations. Canada Mortgage Bonds are the first to be bought, on a non-competitive basis in the primary market. The buying will begin at the end of this year, or in early 2019. The BoC reiterated that this is for “balance sheet management purposes” and has no implication to monetary policy.
To reiterate, Canada’s central bank is buying assets from federally owned companies, guaranteed by the federal government, with money they’re authorized to print by the federal government, secured with assets by the federal government… and it won’t have an impact on monetary policy. We’ll take that statement at face value today, and move onto more important things like “what are CMBs?”
What Are Canada Mortgage Bonds?
Canada Mortgage Bonds (CMBs) are one way lenders access cheap funds for mortgages. Investors fork over cash for a CMHC guaranteed loan, backed by the Federal government. Since the chances of the CMHC and the Government of Canada disappearing overnight are slim, they’re considered secure. Secure investments don’t pay all that much, which is great for lenders and/or borrowers. Low cost funding means more profits for lenders, and less interest paid by borrowers.
Canadian Mortgage Credit Growth (Real)
The annualized pace of mortgage credit growth at large Canadian lenders, adjusted for inflation.
Source: Bank of Canada, Better Dwelling.
This Sounds Goo… Ba… No. Definitely Good… Maybe?
Depends on who you are, and the amount of CMBs bought. The upside is the increased liquidity, which may suppress rates from rising too fast. That would translate into lower funding costs, some of which are passed on to borrowers.
On the other hand, it’s a sign of market weakness. The central bank only provides liquidity ahead of liquidity concerns. Mortgage credit growth fell to multi-year lows, and is likely to drop further as they hike to “neutral” policy rate. Any time we see a government institution step in to address liquidity concerns, it’s a bad sign.
Further, this is the second mortgage liquidity tool proposed just this year. Earlier this year the Office of the Superintendent of Financial Institutions (OSFI) said they’re looking into expanding the covered bond program. The covered bond program is another tool to provide low cost financing for mortgages. If everything is fine, why is the government stepping in to help out on so many levels?
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