Restraining the housing market may be wise — but it remains divisive: Don Pittis

It's pretty clear that the explosive growth in the price of Canadian houses over the last decade was the inadvertent product of an emergency plan to rescue global capitalism in 2008. 

There's more evidence of that in a new book, Firefighting: The Financial Crisis and Its Lessons, published this week by former U.S. Federal Reserve chair Ben Bernanke and two other architects of the rescue plan.

And despite the fact it is widely accepted that Canadian house prices did not need a boost in 2008, a new CIBC report is a reminder of the ambivalence of even the most staid economists over government attempts to withdraw stimulus from the real estate sector after a decade of overheating.

Bernanke's new book lays out the case that when central banks around the world cut interest rates following the 2008 credit crunch, the purpose was to prevent no less than the devastation of another Great Depression.

"We helped shape the American and international response to a conflagration that choked off global credit, ravaged global finance, and plunged the American economy into the most damaging recession since the bread lines and shantytowns of the 1930s," reads the book's introduction.

Critics of the Monday morning quarterback variety have since complained that the scheme — which involved slashing interest rates to zero and bailing out banks to the tune of hundreds of billions of U.S. dollars — merely perpetuated a problem created by irresponsible lending.

But while the current state of the U.S. economy offers evidence that Bernanke and the others may have got it right, there are clear signs that holding interest rates so far below levels the market would otherwise demand has led to a number of distortions.

The U.S. housing market, shattered by the collapse of the subprime lending boom at the heart of the 2008 meltdown, plainly needed the stimulation of low rates. That was not so in places like Canada and Australia, where housing markets were already hot and hadn't crashed.

In an integrated global market, unfortunately, the independence of the Canadian central bank is relative.

If then Bank of Canada governor Mark Carney had tried to hold rates above four per cent while the Fed was cutting to just above zero, disruptions to the Canadian economy would likely have been fatal.

In retrospect, the disruptive effect on Canada's housing market seems obvious. In the heat of the moment, it must have appeared that a little stimulation in the housing market would be positive, encouraging construction and putting money into the hands of existing homeowners.

Stimulus needed?

It soon became obvious that low interest rates had created a Canadian home ownership monster, with prices in some places at one point rising somewhere near 30 per cent in a single year.

Unless you already owned one, houses became unaffordable for many Canadians.

Foreign buyers, liking those shocking rates of return in a safe and stable economy, bid the market up further. Those Canadians who wanted to compete had to sign on to mortgages that sucked up most of their income.

And all the while, people like Stephen Poloz, Carney's successor at the Bank of Canada, began to worry that a housing bubble was forming — and at some point would pop, spreading pain across the economy.

When it comes to the Bank of Canada's interest rate, Poloz has his hands tied now, just as much as Carney once did. He can stray slightly from the path of U.S. interest rates — but not too far.

The bank's solution instead has been to use something called "macroprudential" tools, effectively leaving interest rates low to stimulate the broader economy, but using mortgage stress tests to restrain stimulation of the housing market.

The consumer friendly way the plan has been sold is that if prices do start to fall, or if interest rates begin to rise back to historic levels, young homeowners saddled with a 30-year mortgage commitment will not be overwhelmed by debt or lose their houses.

It also prevents Canadian banks from getting themselves into trouble by lending to people who may default in future.

'But the patient died'

Generally the big banks have been supportive of the stress tests. But CIBC released a report on Tuesday with the cheeky title "Mortgage Stress Test: The operation was a success, but..."

For those who don't recognize it, the concluding part of that phrase usually is "the patient died."

If you examine the report yourself for its subtleties, you'll see that CIBC economist Benjamin Tal offers some arguments for and against stress tests. But the nub of his case is that the stress test should be watered down.

The test — which forces borrowers to show they have enough income to cover a two-percentage-point increase in interest rates — has led to a decline in new mortgages and a move toward alternative sources of funding, including families, says Tal.

At the same time, of course, house prices are falling from their most astronomical heights, which has many people in the real estate sector ready to blame government for the decline.

But would Poloz support rolling back those stress tests when he speaks next Wednesday? Despite the case made by the CIBC report, there are reasons why he may not.

Even with the reported decline in mortgage borrowing, Canadians are still mired in debt that is growing faster than income.

While home sales are falling just now, a mortgage commitment lasts decades. So while the economy may continue to come up roses, a sudden recession — something many have predicted — could abruptly nix a young couple's repayment plans, getting them into serious trouble.

One reason many scoff at those short-sellers who have bet against Canadian banks is that they say the Canadian government will do its best to ensure they stay sound. The stress test does that.

And, as in 2008, the global economy may still need continued low interest rates to keep it healthy. That's what our central bankers are telling us. But house prices?

Even if the market is cooling off a little just now, Canadian houses have risen in value far beyond the level of any other consumer asset over the last decade, making them almost unaffordable for Canadians earning an average wage.

Maybe, as in 2008, the housing market doesn't really need a full dose of stimulus.

Follow Don on Twitter @don_pittis