The main job of the Office of the Superintendent of Financial Institutions (OSFI) is to keep banks out of trouble, and the mortgage stress test ensured none of them were adding riskier creditors to their massive home-loan portfolios. But at the end of January, out of nowhere, the federal banking regulator appeared to go wobbly on the test.
Why? Rita Trichur, one of the better chroniclers of Bay Street, offered a plausible answer. “If you’re wondering why OSFI is suddenly considering fiddling with the stress test as froth builds in the Vancouver and Toronto housing markets, household debt remains high and consumer insolvencies are rising, look no further than Prime Minister Justin Trudeau and his waning political fortunes,” she said in the Globe and Mail on Feb. 13.
You can decide for yourself whether the current group loosened housing regulations for the right reasons, or whether there were more nefarious forces at work
The previous prime minister, Stephen Harper, balked at making it harder to qualify for mortgages, which is one of the reasons household debt is now such a serious problem. Trudeau, via Finance Minister Bill Morneau, introduced the stress test. The real-estate lobby howled, but Morneau held firm and the policy worked: credit growth slowed to a sustainable pace.
Nevertheless, the housing industry, aided by the narrative that life in big cities had become unaffordable, kept up the pressure. The Conservatives promised to adjust the stress test during last fall’s election campaign. The Liberals waited until after they were reduced to a minority government. Morneau’s marching orders from Trudeau included a direction to “review and consider recommendations from financial agencies related to making the borrower stress test more dynamic.”
The re-appointed finance minister got the hint. On Feb. 18, Morneau stepped in front a podium on his way into the House of Commons for Question Period and announced he had made a tweak. “We’ve taken a look at how Canadians can continue to be protected in their investments, in their homes, but at the same time make sure the stress tests are more dynamic to market conditions,” he said at an impromptu press conference that lasted about five minutes.
Starting in April, if you want an insured mortgage, you will have to show you could handle payments at a rate that is two-percentage-points higher than a five-year rate based on recent mortgage insurance applications. OSFI, which sets the rules for uninsured home loans, indicated it would follow the government’s lead. The new calculation will allow riskier borrowers to qualify for bigger loans, and, on the margin, puts upward pressure on prices.
Mortgage Professionals Canada acknowledged the news by tweeting that Morneau and OSFI had “finally” listened. The Canadian Real Estate Association also expressed contentment, saying in a statement that it had been advocating for “changes to the stress test on behalf of potential homeowners who have been sidelined, borrowers who have moved away from the regulated market to the less-regulated options, and real estate markets across the country in need of relief.”
Frankly, there aren’t many markets “in need of relief,” and those that do — Alberta, Saskatchewan and Newfoundland and Labrador — have bigger problems than the stress test. According to CREA’s own assessment, sales of existing homes in January amounted to one of the “stronger readings of the last few years,” and transactions passed year-earlier levels in about two-thirds of all markets, including “most” of the biggest ones.
Kyle Dahms and Matthieu Arseneau, economists at National Bank, estimate that the current stress test, which is based on the posted five-year conventional mortgages posted by the six biggest lenders, constricts an insured homebuyer’s purchasing power by about 22 per cent. The new rules will allow borrowers to increase the size of their loans by about four per cent, based on the latest data, adding “further fuel to a vigorous housing market which is already supported by the recent decline in mortgage rates and a vibrant labour market,” Dahms and Arseneausaid in a research note.
Morneau and OSFI are planning “pro-cyclical” policy, when “counter-cyclical” measures are still needed to offset the stimulative effect of unusually low interest rates. Financial regulation has been elevated in importance since the financial crisis, but officials appear to see it as flexible, unlike managing inflation, which is often described as sacrosanct. “Anyone who has been doing financial regulation long enough knows that as you see these things in play, you realize there are tweaks that could be made,” Carolyn Wilkins, the Bank of Canada’s senior deputy governor, said at a press conference on Jan. 22, when the changes still were under discussion.
The technocratic justification for adjusting the stress test is that it was proving to be somewhat harsher in practice than intended, so an update was in order. A proper financial regulator, responsible to Parliament or that operated at arm’s length from cabinet, might see things differently. Surely it would have preferred to hold the line, judging that the threat of big-city markets such as Toronto and Montreal overheating outweighed whatever minor pain homebuyers and the real-estate industry were feeling.
We can’t know because no such regulator exists in Canada. Those decisions are made deep inside the Finance Department, far from public view. Marie-France Faucher, a spokesperson at the department, said Morneau received advice from the Senior Advisory Committee, a secretive group of senior technocrats that is chaired by the deputy minister of finance and includes representatives from the Bank of Canada, OSFI, Canada Deposit Insurance Corp. and the Financial Consumer Agency of Canada. Canada Mortgage and Housing Corp. was also consulted, she said.
“Strong collegial culture and inter-agency cooperation” is one reason, the International Monetary Fund observed last month, that Canada’s approach to financial oversight “appears to be adequately effective.”
Still, the fund said “first-best” would be to have a single body keeping watch over the financial system, and “second-best” would be elevating the Bank of Canada’s rank within the hierarchy. The reason is transparency and accountability. The fix could be as simple as pulling the Senior Advisory Committee out of the backrooms and replacing the current chair with someone from the central bank.
Until something like that happens, the rules the federal government implements to protect against financial crises will be as credible as the men and women in power at any given moment. You can decide for yourself whether the current group loosened housing regulations for the right reasons, or whether there were more nefarious forces at work.