Bank of Canada won't raise interest rates to cool housing

[cdr108]

Deputy governor says such a move would also negatively affect the broader economy as it emerges from recession

Steve Ladurantaye

Globe and Mail Update
Published on Monday, Jan. 11, 2010 2:37PM EST
Last updated on Monday, Jan. 11, 2010 3:21PM EST


The Bank of Canada won't raise interest rates to cool the country's hot housing market, a spokesman said Monday, preferring to leave any tinkering to the country's Finance Minister.

“Some observers – those who see a housing bubble forming – have said that since low interest rates have stimulated housing market activity, the Bank should now raise interest rates to dampen that activity,†deputy governor Timothy Lane wrote in a speech delivered by an adviser on his behalf in Edmonton. “But that poses a problem.â€

Existing-home sales are up 73 per cent year-over-year, while prices have climbed nearly 20 per cent as buyers take advantage of historically low interest rates to finance purchases.

Those who fear a bubble worry that many people are taking advantage of cheap money to buy homes they wouldn't be able to afford once rates rise, leading ultimately to a crash in prices.

Mr. Lane said the bank understands the concern, but it uses its lending rate to keep inflation in check for the whole economy and the housing market is “only one of several factors†that influence inflation.

Other sectors could be adversely affected if the rate jumped before the broader economy was ready, he said.

“If the Bank were to raise interest rates to cool the housing market now – when inflation is expected to remain below target for the next year and a half – we would, in essence, be dousing the entire Canadian economy with cold water just as it emerges from recession.â€

Instead, he said, the government could increase capital requirements for lending institutions, adjust loan-to-value ratios and change the terms and conditions required to obtain mandatory mortgage insurance.

“These instruments can be targeted to risks to the entire financial system that stem from particular markets or institutions,†he said. “Ultimately, it is the Minister of Finance who is responsible for the sound stewardship of the financial system.â€

In an end-of-year interview with CTV, Finance Minister Jim Flaherty said the government would consider raising the minimum down payment from 5 per cent “to a higher figure†and reducing the amortization period of 35 years to "something less."

But the Minister stressed that the government has not yet made that decision.

"If there is, in the future, evidence of a residential real estate bubble, the tools we have are the tools we've used before, relating to insured mortgages, lending standards, amortization periods and down payments, which is what we acted on in the summer of 2008," Mr. Flaherty said in a late-December interview with The Globe and Mail.

In the summer, the government said it would no longer insure zero-down-payment mortgages or mortgages with an amortization period of more than 35 years.

 

[MBS-Guru]

all those people calling a crash b/c the rates will increase five fold will be really disappointed. They will increase it ever so slightly ..... 1/4 percentage points at a time and it won't even increase that fast. It's in the best interest of the country (say 75% of the pop) to keep this market going rather than popping the bubble

 

[interested]

all those people calling a crash b/c the rates will increase five fold will be really disappointed. They will increase it ever so slightly ..... 1/4 percentage points at a time and it won't even increase that fast. It's in the best interest of the country (say 75% of the pop) to keep this market going rather than popping the bubble

Agree. furthermore, the only 2 ways large scale increases could occur is if the economy is going great gang busters and then prices/wages will also both increase or alternatively we have stagflation where inflation returns with no growth. Then I doubt that prices will increase but they will not decrease significantly either as real assets would be the ones anticipated to hold at least some of their value (vs. say stocks).

 

[GraceCondos]

This sounds like a smart decision to me. Their goal is to moderate house pricing to stop any potential bubble. Raising interest rates would work, but would affect everything else such as car loans, lines of credit, etc.

The strategy of clamping down on the mortgage industry (by increasing minimum % down and lowering ammortization periods) seems to be much more of a "laser" approach - focussing directly on real estate.

If they move forward with those moves, it's going to suck for first-timers, as many may have $15k saved and plan to buy a $300k condo. If they don't get in before they change the rules, they'll need $30k down (if the minimum is raised to 10%). How many years of renting will it take them to save up that additional $15k?

I see this helping the rental market, as people will be forced to continue in their apartments for a few more years...

Only time will tell!

 

[daveto]

During the great depression, there were a couple of key actions undertaken by nations. First, was a devaluation of their currencies in an attempt to gain a competitive export advantage. Second was the need to raise rates to retain foreign capital that had begun to exit their countries in response to default risks and/or better rates of return elsewhere.

It was France who fared the best during the Great Depression because they had the highest level of domestic middle class savings to draw upon.

None of the countries who raised rates did so because they wanted to do so. They did so because they had no choice. The flight of capital would have otherwise strangled their economies.

The high rates were necessary in the short term, but ultimately were a major cause of the Great Depression.

In our current situation, one of the things which makes our structural government deficits and debt sustainable in the short term is the huge pools of retirement savings. By some estimates, the world has $40 trillion of registered retirement savings (pensions, RRSPs. 401k's, etc).

When people talk about "China owning the US Debt", it is such a crock! The US debt is paid for by itself - in particular by borrowing money from the various pension funds, etc which manage these savings.

However, for the forseeable future we will have continuing structural government deficits in most of the developed world. This means that each year the gov't must fund the annual deficit as well as fund the rolled over debt from prior years (ie the 2yr, 3 yr, 5 yr, etc expiring bonds).

Exacerbating this situation is the demographic bulge of retirement/pension drawdowns as boomers start to retire. Thus we will go from a period of increasing total global retirement assets, to a period of flat or even decreasing global retirement assets.

History suggests there will come a point where there will be too many borrowers chasing too few lenders. And at that point we'll see sharp and unexpected jumps in interest rates on national lines as countries are forced to woo foreign capital in the same way that their 1930's predecessors did. Those countries that have the largest pools of domestic assets to borrow from will fair the best, just as France did in the 1930's.

I should note further that the Gold Standard was also a major cause of the Great Depression, and our present fiat currency system changes the game. Perhaps quantitative easing can allow countries to avoid the trap faced by their 1930's predecessors.

Alternatively, if Gov't get their deficits and debts under control, then perhaps none of this may take place. Time will tell.

My point is that all countries need to refinance their debt, and if there are not enough buyers then they have no choice but to raise their rates. Otherwise the countries governments shut down.

Please note that I am not predicting what will happen. But I am pointing out that the arguments about why "gov't would never choose to raise rates without a sustained recovery" were also bandied about in the 1930's.

 

[interested]

During the great depression,
History suggests there will come a point where there will be too many borrowers chasing too few lenders. And at that point we'll see sharp and unexpected jumps in interest rates on national lines as countries are forced to woo foreign capital in the same way that their 1930's predecessors did. Those countries that have the largest pools of domestic assets to borrow from will fair the best, just as France did in the 1930's.

Perhaps quantitative easing can allow countries to avoid the trap faced by their 1930's predecessors.
My point is that all countries need to refinance their debt, and if there are not enough buyers then they have no choice but to raise their rates. Otherwise the countries governments shut down.

Please note that I am not predicting what will happen. But I am pointing out that the arguments about why "gov't would never choose to raise rates without a sustained recovery" were also bandied about in the 1930's.

I think we will have alot larger problems if governments have to raise rates without a sustained recovery than worrying about whether house prices will hold. Like having a job, putting food on the table. Having a table to put food on.

I agree with everything said here but if God forbid we should reach these points, all other arguments and issues pale to basic necessities of life. Who cares at that point if you own or rent. You just want shelter. You will not be worrying about investment income. You will be happy just to "survive".

 

[daveto]

In support of my prior post, note the following quote from Ben Bernanke in 2004, on the topic "Money, Gold and the Great Depression"

http://www.federalreserve.gov/boarddocs/speeches/2004/200403022/default.htm
"To stabilize the dollar, the Fed once again raised interest rates sharply, on the view that currency speculators would be less willing to liquidate dollar assets if they could earn a higher rate of return on them. The Fed's strategy worked, in that the attack on the dollar subsided and the U.S. commitment to the gold standard was successfully defended, at least for the moment. However, once again the Fed had chosen to tighten monetary policy despite the fact that macroeconomic conditions--including an accelerating decline in output, prices, and the money supply--seemed to demand policy ease.

 

[Eug]

More than 5% down doesn't necessarily mean 10%.

Personally my gut feeling is a 7.5% down approach, perhaps with a 30-year amortization max is reasonable.

OTOH, I wouldn't be surprised if they chose 10% simply because it's a nice round number.

 

[cdr108]

all those people calling a crash b/c the rates will increase five fold will be really disappointed. They will increase it ever so slightly ..... 1/4 percentage points at a time and it won't even increase that fast. It's in the best interest of the country (say 75% of the pop) to keep this market going rather than popping the bubble

while i agree that BoC will try to increase the bank rate slowly, fixed term mortgage rates are dictated by LT bond rates.

More than 5% down doesn't necessarily mean 10%.

Personally my gut feeling is a 7.5% down approach, perhaps with a 30-year amortization max is reasonable.

OTOH, I wouldn't be surprised if they chose 10% simply because it's a nice round number.

my guess is 10% dp and 30-year amortizations maximum also.

 

[interested]

More than 5% down doesn't necessarily mean 10%.

Personally my gut feeling is a 7.5% down approach, perhaps with a 30-year amortization max is reasonable.

OTOH, I wouldn't be surprised if they chose 10% simply because it's a nice round number.

Reality though it may sound harsh is that not everyone should be buying a home. what is so terribly wrong about waiting until one can afford something rather than having to have everything today and now. With credit, and selfishness, everyone wants everything immediately. advertisers market everything on credit. Our parents used to buy "WHAT THEY COULD AFFORD". Expecting someone to wait until they can get 10% down is not an unreasonable trade off. It was only recently that we went down to 5% downpayments. this was not the norm just a few years ago and trying to withdraw it is a bit now like trying to wean an addict off his addiction. As a society, we all need to start to pear down our wants and look at what is really important and accept that we can't have everything we want when we want it. Otherwise, we lose our financial freedom and depend on a hopefully benevolent lender to keep us afloat.

 

[MBS-Guru]

while i agree that BoC will try to increase the bank rate slowly, fixed term mortgage rates are dictated by LT bond rates.

You're absolutely right .... the bond market will ultimately affect where we stand in terms of the interest rates ..... BUT the bond market can be manipulated ..... IE gov't flooding the market with new issues and buying it themselves a la USA via CMHC's Canada Mortgage Bond program ..... either way, no one really knows how it will settle in the next few years, it will be a time of uncertainty for sure. Remember, Carney will try to devalue the Canadian dollar if possible to 65-70 cents on the dollar, that means he will be reluctant to increase rates for that reason alone. There are many factors at play ....

 

[CN Tower]

When people talk about "China owning the US Debt", it is such a crock! The US debt is paid for by itself - in particular by borrowing money from the various pension funds, etc which manage these savings.

Not so...

 

[rbt]

When people talk about "China owning the US Debt", it is such a crock! The US debt is paid for by itself - in particular by borrowing money from the various pension funds, etc which manage these savings.

While a majority of US debt is domestic there is still about 3.4 Trillion of US debt is under foreign ownership. A demand for immediate payback would cause rather substantial issues for the US. Of course, China and Japan both have significant interest in the US going strong so they would never make such a demand.

 

[daveto]

Not so...

CN Tower, did you total up the figures for the countries listed in your post?

The total is appox $2.8T. That is less than 25% of the present US total of $12T (also shown in your post). I wasn't suggesting that China has NO US gov't debt. Of course we all know they have some.

So where do you think the other 75% comes from? It comes from intragovernment borrowings (ie other US govt departments) and from domestic investors.
Consider further the following link from Wiki (from June 2008)
http://en.wikipedia.org/wiki/File:Estimated_ownership_of_US_Treasury_securities_by_category_0608.jpg



Going further in depth, there is also a huge volume of non-gov't corporate debt in all countries which needs to be rolled over (consider the recent Dubai World situation).

 

[js97]

Those that worry china might cash in on the U.S. Debt?

do you really think they will shoot themselves in the foot?

If china floods the market with U.S. debt, it will also cause those same debts to be completely worthless.
Whate ever the trillion figure is... it will be worth a fraction of it...The same way it might bankrupt the U.S., it will shrink China's savings.

Then what? the U.S. is still by far their largest consumer.

it's not going to happen..

Your friend owes you a lump of money, and you know he can't pay up. Will you ask for the lump sum, potentially lose the friend ship, or continue receiving interest payments..