A major international bank said today that Canada's best hope to avoid a real estate crash would be for policymakers to raise interest rates by half a per cent over the medium term.
"We believe that the best way to engineer a soft landing in the housing sector would be for the Bank of Canada to increase its policy rates slightly," says the report, from international financial conglomerate Nomura's contributing economist, Charles St-Arnaud.
House prices have more than doubled since 2001, and increased 6.7 per cent in the past year alone. Along the way, that housing boom has created a debt balloon, as personal debt loads recently hit a record 142 per cent of disposable income, according to the latest official data.
In recent months, policymakers in government, at Canada's central bank and in the private sector have stepped up a campaign to try to slow down Canada's housing market, with middling success.
As a result of the sharp increase in prices over the past few years, most indicators of the housing market show that house prices are overvalued, Nomura noted in its report. The ratio of home prices to rent, and home prices to personal disposable income levels are each 70 and 45 per cent higher, respectively, than their average since 1980, indicating some significant overvaluation.
All else being equal, St-Arnaud says home prices would have to decline by 10 to 15 per cent to bring both metrics closer to equilibrium. But that's unlikely to happen as long as rates remain tantalizingly low.
To stem the rising debt tide, the central bank and government essentially have two major weapons at their disposal — changing the rules for who can get mortgages, and changing the rates at which they are offered.
CMHC rules adjusted
The Department of Finance has already used the first weapon twice. In 2010 and then again in 2011, Finance Minister Jim Flaherty altered the rules for who can obtain a CMHC-insured mortgage. (The Canada Mortgage and Housing Corporation is the Crown corporation charged with managing Canada's housing industry, insuring the vast majority of Canadian home loans.)
Changes to CMHC rules have indeed trickled down to the broader market. Among other changes, Flaherty moved the maximum amortization period from 35 years down to 30, and increased the amount of minimum down payment from zero to five per cent. Both moves were aimed at ensuring Canadians had more equity in their homes, and made it harder for them to take on too much debt.
That slowed the market, but only somewhat. Some are now calling for Ottawa to bring the maximum down to 25 years and the minimum up to 10 per cent, moves that Nomura estimated Thursday would increase the mortgage payment for a new buyer by about 8.5 per cent.
The finance minister has expressed a reluctance to do so, but also says he stands ready to intervene if needed. It's a difficult political issue because elected officials are unlikely to want to do anything heavy-handed that would result in drastically lower home prices — even if experts suggest that would be better for the economy in the long run.
If policymakers want to slow down the market further and get the soft landing they want, the more effective option, Nomura argues, is a rate hike.
Housing overvalued: Nomura
"Since [mortgage] rules have been tightened three times over the past few years, the Bank of Canada may conclude that it needs to resort to the last line of defence, especially since [other] measures could be too strong to engineer a soft landing," St-Arnaud said.
A sharp increase of a full percentage point — moving the central bank's target rate from one per cent to two per cent — would have a big impact on affordability. Nomura estimates average mortgage payments would increase by 11 per cent per month.
Such a rate hike would directly impact variable rate holders, which made up 24 per cent of the mortgage market in 2010, the most recent year for which accurate statistics are available.
That ratio is likely to have dropped as more and more buyers locked in at even lower fixed-term rates in recent months.
More likely, then, is for the Bank of Canada to raise rates, but not by quite as much as a full percentage point.
"A small increase, around 50 [basis points], in the policy rate would be enough to change household behaviour and slow the accumulation of debt, without jeopardizing growth," St-Arnaud said.
"Since actions speak louder than words, a small rate hike could be the catalyst for households to change their behaviour and slow the accumulation of debt and the housing sector," he noted.