Canada’s central bank head piqued the interest of economists, and not because of his dazzling personality. Speaking to lawmakers, the Bank of Canada (BoC) Governor Tiff Macklem explained quantitative ease (QE) has no impact on housing. He further explained demand and the cost of housing determines mortgage demand. The statement was odd, not because he contradicts himself a little later on. It was odd because it directly conflicts with the central bank’s own reports and research.
This sparked a lot of discussion in the finance community, but little in the public. Save for one Big Six bank telling clients the BoC was “misleading,” most media disseminated his statements at face value. Let’s dissect the governor’s claims using almost nothing but their own research over the past two years.
“There’s no direct link between quantitative easing and the number of mortgage loans… What determines mortgage loans is how many houses people want to buy and what the cost of those houses are.”
— Bank of Canada Governor Tiff Macklem, Mar 3, 2022
Quantitative Ease Is A Tool For Creating Inflation
Quantitative ease (QE) is an unconventional monetary policy tool to create inflation. It’s complicated, but the gist is the central bank buys government bonds competitively. Imagine a buyer that shows up and wants to buy something at any cost. That’s the central bank — their goal is to get the worst deal and pay the most for bonds. By doing this, they can drive down the rate of interest, because who pays a sucker a premium?
Why would a buyer, such as the BoC, compete with investors to get the lowest return possible? Let’s see what the BoC itself has to say about this.
“When the Bank buys government bonds of a given maturity, it bids up their price. This, in turn, lowers the rate of interest that the bond pays to its holders. When the interest rate on government bonds is lower, this transmits itself to other interest rates, such as those on mortgages and corporate loans.”
In other words, they flood the system to drive down interest costs to stimulate demand. The goal is to get more loans for large financed goods, like machinery & equipment, and mortgages. One more time, for the people in the
“… if our purchases lowered the yield on five-year government bonds, this would be reflected in lower interest rates on five-year fixed-rate mortgages. And that makes it cheaper to borrow to buy a house.”
Lowering interest rates is the primary tool a central bank uses to create inflation. By lowering rates, the central bank is trying to stimulate demand faster than supply. Yes. The *goal* is to outrun supply to create a non-productive price increase, known as inflation.
When interest rates hit near zero or they need more targeting, they use QE. For example, if the BoC wants to stimulate fixed-rate mortgage demand, they buy 5-year GoC bonds. Which they did. A lot of. If they need more demand for mortgages specifically, they buy mortgage backed securities. Which they also did. A lot of. QE is used to directly influence mortgage demand. It’s the goal.
It’s important to understand, this isn’t a difference of opinion on interpretation. Governor Macklem acknowledges this point in the same committee meeting. “Quantitative easing together with the other measures we took did lower mortgage rates and that contributed to the strength of the housing market,” he explained.
His take is that QE is a tool for creating inflation and creating demand for mortgages. If he’s bragging about his performance, it was successful at creating demand. If he’s summoned to Parliament to explain wtf is going on, the market did it. Okay…
The BoC Has Explained, By Definition, Quantitative Ease Raises The Price of Homes
The most toxic mechanism of QE is the desired impact on home prices. Once again, the goal of QE is to raise the price of goods by stimulating inflation. Demand is intentionally created to overload supply and the GOAL is higher prices. Yes, a desired effect. The BoC acknowledges this as a good thing when discussing the other side of the asset.
“QE can boost wealth by increasing the value of assets…But of course, these assets aren’t distributed evenly across society. As a result, QE can widen wealth inequality.”
— Tiff Macklem, Governor, May 13, 2021
To a large portion of the population, increasing the value of a home is a good thing. Nothing wrong with making money. The issue is when demand is juiced to the point where prices are rising $80,000 per month. In that case, it’s probably time to dial back the stimulus, at least a little.
Inflating real estate prices by means of QE is also a little more problematic than say, the stock market. If stocks rise, the impact isn’t an issue for society. If home prices are driving the asset wealth gains, you now have a human essential rising out of reach by the day. One person’s over-inflated home equity is another person’s barrier to secure shelter.
Bank of Canada Research Shows Low Rates From Programs Like QE Raise Home Prices
Governor Macklem has perpetuated traditional logic that low rates improve affordability. The idea here is that if you’re paying less in interest, the cost of servicing the same debt falls. The Guvna’ points to supply and demand as the reason home prices are rising. There’s just too many buyers for the number of homes that exist — just like the goal of QE.
For now, let’s gloss over low rates, driven lower by QE, causing an extra $150 billion in excess housing sales, for now. The big issue here is the BoC knows low rates drive home prices higher. How do we know this? Because the BoC literally produced research and stated that fact.
A BoC report released at the end of 2021 found mortgage rates fell dramatically. They estimate the average rate for a 5-year fixed-rate mortgage went from 8% in 1990 to 2% in Q2 2021. With the cost of borrowing 75% lower, they expected affordability to improve. It, of course, did not.
“… when interest rates fall, many households simply adjust by borrowing more,” concludes the study.
Okay, but if that research wanted to be read by the Governor, they should probably put it in a more prominent place. Perhaps drop that sh*t somewhere obvious that the BoC has to use daily. Oh, wait, they did.
The BoC Changed Its Whole Forecasting Model Based On The “Innovation” Of, Increased Credit Raises Home Prices
Last year the BoC rolled out ToTEM II, the third update in 15 years to their primary forecasting tool. A fundamental change in this update is a new focus on indebtedness and home prices. Before the update, it wasn’t believed that credit access changed consumption patterns. Apparently the BoC didn’t know anyone in university who got their first credit card because it came with a free beer cozy.
The reason for this change? “… the main innovation is that borrowers now contribute to overall housing demand, allowing mortgage debt and HELOCs to influence prices,” reads the technical notes.
Yes, you read that correctly. The BoC changed its primary forecasting model to acknowledge a hip new innovation — credit influences home prices. Not just the expansion of credit and low rates like we discussed in the above study. But HELOC and mortgage refinancing are now a part of their home price forecasting. They’re fully acknowledging that low rates caused in part by QE will increase prices — in a direct way.
QE Has Stimulated Record Investor Demand, Crowding Out End Users With Cheap Debt
That brings us to our next point — Governor Macklem’s supply and demand imbalance point. In his opinion, as well as most policymakers, they just need to outrun the scenario designed to not be outrun. They completely dismiss that low rates, HELOC leverage, etc, all contribute to increased demand from QE.
Homebuyers aren’t the only ones who receive cheap mortgages, investors do as well. If you’re lending money for less than the rate of inflation, they’re going to want a lot of what you’re giving away. It’s essentially an offer of free money. Investors get to leverage their existing wealth with this credit stimulus. Those investors also happen to be bidding against end-users, like first-time buyers.
If only there was a data point on this issue. Oh, snap. The BoC, bless its soul, also did a study on this. They found cheap capital flooded the market with real estate investors. Their calculations show annual growth of investors doubled last year. It was by far the largest growth for any segment, now representing 1 in 5 personal mortgages. That’s also worth a second look.
Personal mortgages means they excluded all corporate mortgages, used only by investors. Not all personal mortgages are for investors, but all corporate loans are. The share is even higher than the study shows, and the increase in market share for investors was at the expense of first-time buyers.
Ontario’s land registry supports similar findings, with investor growth soaring recently. They found 1 in 4 property sales in the province were to investors, up 8 points from a decade before. The investor segment became larger than first-time buyers in 2016, when the US Federal Reserve declared Canada to be in a real estate bubble.
QE helped the segment capture 3 points more market share shortly after launch. The trend is even worse in Toronto, where investors are behind nearly 1 in 3 home purchases. Higher competition means higher prices. In a competitive market, every first-time buyer had to beat out an investor.
Governor Macklem said QE has no direct impact on mortgage consumption, and rising prices are due to demand. If it wasn’t clear, I disagree with that statement. His central bank disagrees with that statement, even if they won’t tell their boss. Canada’s oldest bank disagrees with his statement. Basic economics disagrees with his statement.
Heck, even Tiff Macklem disagrees with his statement by the end of the committee meeting. Not a huge surprise, since he’s always looking out for the little guy. He really won me over when he said the central bank’s use of QE inflated asset values but caused inequality.
Regarding rising prices due to a demand imbalance, he’s right. QE stimulated the excess demand though. Real estate is a dual-purpose asset — it’s an investment and shelter. To serve as shelter, it needs to be profitable for an investor to charge rent higher than the purchase value or, sell back to an end user shortly after. For an end-user to use a home as shelter, they need to bid a property to the point of being unprofitable for an investor. QE further slants a market to be driven higher.
When tight cities see investors using existing capital to levy up with stimulus, and home sales are at a record — maybe the market doesn’t need more stimulus? The BoC is largely only improving investor margins and drumming up demand for GDP.