Lender of last resort (BoC) vs Subprime Lender of last resort (BC)

British Columbia breathing new life into the American dream

The subtitle is alluding to For Canadian GTA and GVA residents, the American Dream is dead

It is 10pm in the night and just came back in the house after clearing the snow off the drive way. I should go straight to bed but the events of today have taken away my sleep. What a day!

In the morning, Bank of Canada releases the Financial System Review — December 2016. If you have been following the Canadian housing and debt metrics, there was nothing surprising in the report. The report highlight three vulnerabilities that BoC sees in the financial system

ƒ1- The elevated level of Canadian household indebtedness

ƒ 2- Imbalances in the Canadian housing market, and ƒ

3- Fragile fixed-income market liquidity.

We will focus on the first two aspect of the report which are inter-related.

Policy Steps

First, the report mentions the policies implement or steps taken to reduce the risks

Higher qualifying rate for debt-service calculations: Under mortgage insurance rules, a borrower’s ability to make payments must now be assessed using the greater of the contract interest rate or the benchmark posted rate for five-year fixed-rate mortgages. This requirement was already in place for high-ratio insured mortgages that have variable rates or fixed rates with terms less than five years. It now extends to all insured mortgages. For newly affected borrowers, this change currently represents an increase in the qualifying rate of about 2 percentage points. The higher qualifying rate acts as a type of through-the-cycle stress test to ensure that borrowers can still afford their mortgage payments even if interest rates are higher when they renew or if their household income is reduced. ƒ

Restrictions on the eligibility of low-ratio mortgages for mortgage insurance: The criteria for portfolio insurance and other discretionary mortgage insurance have been tightened to bring them in line with the rules for insurance on high-ratio mortgages. This type of insurance is used by lenders to reduce credit risk in a mortgage portfolio and to access funding through the National Housing Act Mortgage-Backed Securities or Canada Mortgage Bond programs. Under the new restrictions, insurance will no longer be available for mortgages with an amortization period longer than 25 years or those obtained in refinancing transactions.

ƒ Property transfer tax for foreign buyers (Vancouver): On 25 July, the BC government announced a 15 per cent transfer tax on residential properties in the Greater Vancouver Regional District for purchasers who are neither permanent residents nor citizens of Canada. The tax came into effect on 2 August. ƒ

Empty homes tax (Vancouver): The City of Vancouver has introduced a tax on empty homes, set at 1 per cent of a home’s appraised value each year, to take effect in 2017. ƒ

Housing affordability measures: Governments have announced new plans to make housing more affordable, especially for first-time buyers and lower-income households. Among these measures, the Government of Canada announced in Budget 2016 additional funding for affordable housing. It has also completed a consultation process on the National Housing Strategy. In Ontario, the provincial government announced an increase in the land transfer tax rebate for first-time buyers. As well, the BC government announced a $500 million investment in affordable housing.

Impact of these policies

Chart 4 shows the impact of the higher qualifying rate on borrowers if the measures had been in place during the 12 months ending in September 2016. All else being equal, about 31 per cent of high-ratio mortgages issued nationally during that period would not have qualified. The higher qualifying rate used in debt-service calculations will immediately improve the quality of new mortgages and gradually make the overall stock of debt more sustainable than it would have been without the changes. Table 2 shows the impact that the higher qualifying rate would have had in different cities. Across the country, housing expenses and payments on consumer debt would have caused a significant proportion of borrowers to exceed either the TDS or GDS qualifying criteria (top row). The new qualifying rate used in debt-service calculations would have had its largest effects in the cities where house prices are the highest relative to incomes, such as Vancouver, Toronto and Calgary. This result can best be seen by looking at the GDS criterion alone, which assesses affordability only against housing expenses (second row of Table 2). In cities such as Montréal, Ottawa–Gatineau and Halifax, where house prices are not as high, the consumer debt measured in the TDS criterion plays a relatively larger role.

Consumer debt is usually much smaller than a mortgage, but since it can have considerably shorter amortization periods or higher interest rates, it can still have an important effect on debt-service ratios. To qualify under the new rules, some of these borrowers could have chosen a less-expensive home, reduced non-mortgage debt or made a bigger down payment (possibly funded by a co-lending arrangement). To meet the new criteria through less mortgage borrowing alone, the average mortgage would need to be reduced by roughly 10 per cent. Almost all (95 per cent) of affected mortgages would have qualified with a 20 per cent reduction in borrowing.

Beyond the higher qualifying rates used in calculating debt-service ratios, the tightened rules for obtaining portfolio insurance and other low-ratio mortgage insurance will also affect the accumulation of household debt. For example, more than 40 per cent of recently issued portfolio-insured mortgages had amortization periods longer than 25 years, and a large portion involved refinancing transactions, neither of which are eligible under the new rules. Without access to mortgage insurance, refinancing and long amortization transactions have already become slightly more expensive or less available.

Borrowers affected by any of the new rules may seek out less-regulated, higher-cost lenders, such as mortgage investment corporations and private mortgage lenders. Since these lenders are not subject to OSFI regulations and, unlike mortgage finance companies, do not use mortgage insurance, they are not constrained by the new rules. Careful attention from authorities will be needed to monitor any increase in vulnerabilities resulting from greater use of alternative lending channels.

So in a space of three paragraphs, BoC has twice mentioned that borrowers will approach high cost unregulated lenders. Here it seems that BoC is pretending unregulated mortgage lending will be a new phenomenon but as I cited earlier in Liar Loans are common in Toronto residential real estate, unregulated mortgage sector as well as down right fraud is thriving in the real estate sector.

Vulnerability 1: Elevated Level of Canadian Household Indebtedness

Increasing household debt and strong house price growth have continued to reinforce each other, with the national ratio of debt to disposable income approaching 170 per cent

Among high-ratio mortgages, the proportion of borrowers with a loan-to-income (LTI) ratio over 450 per cent rose through the third quarter of 2016.

This trend is partly fuelled by rising house prices, particularly in Toronto and Vancouver. For example, almost half of the high-ratio mortgages originated in Toronto in the third quarter of 2016 had LTI ratios exceeding 450 per cent, up from 41 per cent one year earlier.

This trend is partly fuelled by rising house prices, particularly in Toronto and Vancouver. For example, almost half of the high-ratio mortgages originated in Toronto in the third quarter of 2016 had LTI ratios exceeding 450 per cent, up from 41 per cent one year earlier. Moreover, high LTI mortgages are spreading throughout the Toronto area (Chart 3).


It seems Toronto followed by Vancouver is home to most indebted residents.

Since the above is by BoC, it makes the statement in a neutral manner. But if you want to be awoken from your slumber by sensational reporting, Bloomberg has you covered:

Canada’s Gravity-Defying Household Debt Swells to C$2 Trillion

“Household indebtedness continues to defy gravity and remains the Achilles heel of the Canadian economy,” said Charles St-Arnaud, senior economist at Nomura Securities International in London, who has worked in Canada’s finance department and central bank. “Continued increase in yields and job losses remain the biggest risks.

Vulnerability 2: Imbalances in the Canadian Housing Market

Strong fundamentals underpin housing markets in the Greater Vancouver Area (GVA) and Greater Toronto Area (GTA), but self-reinforcing price expectations may also be supporting price increases.

Though BoC doesn’t mention it as it becomes a political question, but rising house prices will start affecting Canadian society which I covered earlier in Can rising real estate prices lead to rise of alt-right in Canada?and Canadian dream is alive for the wealthy class.

BoC conclusion

But as CMHC hinted earlier Worry about Canadian real estate but don’t lose sleep over it, BoC also summarizes the report that there is nothing to worry about

The overall level of risk to Canada’s financial system remains largely unchanged from six months ago, the Bank of Canada said today in the Financial System Review (FSR). The Bank continues to highlight two key vulnerabilities related to Canadian households: high levels of indebtedness and housing market imbalances. A third ongoing vulnerability is the potential for fragility in fixed-income market liquidity.

Nonetheless, the Canadian financial system remains resilient as the nation’s economy improves and financial reforms in Canada and worldwide progress.

So you see, there was nothing new here and I could have waited till the weekend to summarize the report.

WTF moment in Vancouver

But in the afternoon, well it was afternoon here in Toronto, Premier of British Columbia makes a housing policy announcement that left everyone (except for developers and brokers) befuddled.

Premier Christy Clark announced Thursday that a new provincially backed loan program would match the amount a first-time buyer has saved for a down payment — up to $37,500, or five per cent of the home’s purchase price.

Clark painted the move as an attempt to help middle-class British Columbians overcome the hurdle of saving for expensive down payments. Not everyone has a parent they can borrow money from to get into the housing market, and some need government’s help, she said.

Thankfully no one, except for realtors, was fooled by this step. Rather most were aghast as it just adds to fuel to the crisis. If people cannot afford to buy a house at current low mortgage rates, giving them interest free loans for five years is akin to offering teaser rates to subprime borrowers before the 2008 crisis. In effect, BC government is acting as a subprime lender here.

First, some responses on social media that capture the WTFness of this:


Adding to the WTFness of it all, Christy Clark RTs own praise by none other than a mortgage lender.

Joshua Gottlieb, National Bureau of Economic Research faculty research fellow, UBC

“It’s a pretty bad idea. It is counter-productive and if you give people more purchasing power, they will be able to bid up the prices of the homes that they’re looking at, and that price increase will eat up any benefit from the subsidy. The same people who were going to compete for a home at $500,000 are still going to be competing for that same unit, but at a higher price. They’re just going to compete away the benefit. The only people who gain are existing homeowners or developers who benefit from these higher prices.

“This is not going to improve affordability anywhere in the market and if anything will make it worse, for sure in the lower end and possibly creeping up above that $750,000 [cut-off price]. Different parts of the government’s policies really don’t fit together. They claim to want to promote affordability but they want higher prices. Well, higher prices are the opposite of affordability, so it just doesn’t fit together at all.

“There is no way there was any serious analysis done on this. You can see that even from the press conference this morning which claimed that it won’t increase prices. Well, it’s not going to increase supply and it’s supposed to increase demand, so how is it not going to increase prices? There’s something missing in this analysis. There’s no way there was any serious economic analysis.

“It’s pretty rare that there are so many economists who agree on this. It’s just shockingly illogical.”

From Macleans:

B.C.’s free loans to homebuyers won’t buy much in Vancouver

Not everyone qualifies for this homebuyer subsidy, mind you — only people struggling to get by on household incomes of less than $150,000 a year can use it. And don’t go thinking you can buy a mansion, either: the maximum purchase price under Clark’s plan is $750,000.

Which, if you’re looking for a house and not a condo near downtown, leaves you with limited options.

How limited? Well, according to Realtor.ca, there are only four houses available for under $750,000. They don’t come with land. And you’ll have to build two of them.

From Metro Vancouver

B.C.’s interest-free loan to homebuyers offers much risk, few rewards: economists

Pumping money into the demand side of Metro Vancouver’s already supply-constrained real estate market will push prices higher, especially for condos, said the economists.

The program could encourage more speculation in Vancouver’s market, which is already helping to drive prices far beyond the range that local incomes can support.

Somerville described a situation whereby a homebuyer gets the government loan, then sells the property at the five year mark — before the payments kick in.

“If I sell and the price has gone up by more than the loan payments from the provincial government, they’ve given me a great loan I don’t have to make payments on,” Somerville said.

People are already stretched from attempting to get into the market as prices rose at nosebleed levels throughout 2015 and 2016. Davidoff wondered “who’s left?”

“I think we’re probably scraping the bottom of the barrel in 2017,” he said.

As I said earlier, brokers are pretty happy



We all know that low interest rates are playing havoc with the housing market. By making cost of borrowing low it acts as a self reinforcing mechanism by allowing borrowers to take on ever increasing amount of debts to buy expensive houses which results in houses becoming more expensive. Now borrowers who couldn’t afford a house at such low interest rates will be able to get loan at zero interest rate for 5 years. After 5 years, the interest rate on the loan will not be the current market rate but the market rate prevalent at that time. What guarantee is there that the borrower will be able to pay market interest rates at that point? The assumption here is that income of the borrower would have increased in 5 years time enabling him to afford the mortgage at market rates. But I haven’t seen any hints at the horizon that incomes of Canadians are increasing. Rather as I quoted in Will Canadian workers go the way of horses?

From CIBC research report

Is the quality of employment in Canada in decline? We think so. By looking at the distribution of part-time vs. full-time jobs; self-employment vs. paid-employment; and the compensation of full-time paid employment jobs in more than 100 industry groups, we observe a slow but steady deterioration.

As illustrated in Chart 5, the declining share of young Canadians in the labour market can bias our direct measure upward. At the same time, the rising share of older Canadians that are less engaged in the labour market can bias the measure downward. Chart 9 overcomes that problem by focusing on the age group between 25 to 54. The story is the same: The share of lower-paying jobs has been on the rise.

Keeping all things the same, Christy Clark’s proposal is a recipe for disaster which will end badly for the province and probably the country.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s