Evidence of meeting #67 for Finance in the 42nd Parliament, 1st Session. (The original version is on Parliament’s site, as are the minutes.) The winning word was mortgages.
A video is available from Parliament.
Liberal
The Chair Liberal Wayne Easter
If members are ready, we'll call the meeting to order. Welcome to the first session of the new year 2017.
This afternoon, pursuant to Standing Order 108(2), we're starting a study on the Canadian real estate market and home ownership in relation to housing prices increasing in certain areas across the country.
We have three witnesses, and we'll start with Sylvain Leduc, deputy governor of the Bank of Canada, and Don Coletti, adviser to the governor.
The floor is yours, Sylvain. Welcome.
Sylvain Leduc Deputy Governor, Bank of Canada
Good afternoon, Mr. Chair and distinguished members of the committee.
Thank you for the invitation to appear before this committee. My colleague Don Coletti, who is an advisor to the Governor, is joining me today.
We are pleased to be able to contribute to your timely study on the Canadian real estate market. The Bank of Canada has a mandate to keep inflation low, stable and predictable. Given the importance of a well-functioning financial system in achieving our inflation goal, we provide our assessment of the stability of the Canadian financial system twice a year through our Financial System Review. Let me thus focus my remarks on financial stability.
Our assessment starts by identifying the financial system's most significant vulnerabilities; this is important since financial vulnerabilities can help propagate and amplify shocks to the economy, leading, among other things, to larger deviations of inflation from our 2% target.
Over the past few years, we've highlighted two key vulnerabilities that are relevant to your study: high levels of household indebtedness and housing market imbalances. These two vulnerabilities clearly interact with one another, as households borrow more to buy more expensive homes.
Let me briefly discuss these two vulnerabilities in turn.
The first one, indebtedness, is well known. The ratio of debt to disposable income in Canada is now approaching 170%. This ratio has been rising steadily since the early 2000s. Additionally, the aggregate number masks worrisome patterns regarding how this debt is distributed. For example, our analysis shows that debt has become more concentrated over time in households with higher levels of indebtedness. Compared with their less indebted counterparts, these households tend to be younger and have lower incomes.
The second vulnerability concerns house prices, which now stand at a record of almost six times the average household income on a national basis. What's more concerning here are the imbalances in some cities, most notably Toronto and Vancouver. The price increases we've seen in those cities have been caused by a number of factors, ranging from demographics to low interest rates to constraints on land use. We've also highlighted our concern that expectations of future price growth may be a contributing factor. Because these expectations can change rapidly, the imbalances that have emerged make it more likely that shocks to the economy could cause a drop in prices.
In light of these vulnerabilities, the most important risk to the financial system remains a large and persistent rise in the unemployment rate across the country, which creates both financial stress for many highly indebted households and a correction in house prices. In this scenario, households significantly cut back their consumption spending, while a rise in defaults and a decline in collateral values exert stress on lenders and mortgage insurers. Although we see a low probability of this risk materializing, its impact would be substantial if it were to occur. This is why we judge this risk to be elevated.
That said, I hasten to add that we've concluded model simulations to analyze the effects of such a shock and found that the buffers in the Canadian financial system would be sufficient to absorb its impact. While there would be stress, the financial system would remain resilient.
As you know, the federal government made important changes to housing finance rules last fall. These changes should reduce the rise in highly indebted households over time by ensuring that borrowers are more resilient to potential future headwinds. We are not expecting the regulatory measures to lessen this vulnerability overnight, because it will take time for the number of highly indebted households to decline significantly.
It's also worth emphasizing that under the new mortgage finance rules, the ability of all insured borrowers to make debt service payments must now be assessed using an interest rate that is higher than the prevailing market rate. As well, applicants must show they can cover the costs associated with servicing not only their mortgage but also their total consumer debt.
We expect this more stringent test will reduce vulnerabilities not only in Toronto and Vancouver, but also in cities where house prices are not as high relative to incomes, such as Montreal, Halifax and here in the Ottawa-Gatineau region.
The last point I'll make is that the Bank of Canada can best contribute to long-term financial stability by keeping inflation low, stable and predictable.
To achieve our inflation mandate, we cut interest rates after the financial crisis and have done so twice since 2014, after oil prices collapsed.
Our actions supported income growth and the economic recovery we've seen, helping mitigate households' financial stress along the way. This policy, coupled with other macroprudential tools aimed directly at financial vulnerabilities, is helping to preserve the stability of our financial system.
Thank you for your attention. We will be happy to answer your questions.
Liberal
The Chair Liberal Wayne Easter
Thank you very much, Sylvain.
Turning to the Canada Mortgage and Housing Corporation, we will now hear from Michel Tremblay, senior vice-president of policy, research, and public affairs; and Michel Laurence, vice-president, housing markets and indicators.
Welcome, the floor is yours.
Michel Tremblay Senior Vice-President, Policy, Research and Public Affairs, Canada Mortgage and Housing Corporation
Thank you, Mr. Chair. It's a pleasure to be here.
As you know, our president and CEO, Evan Siddall was scheduled to meet with the committee today. Unfortunately, Mr. Siddall cannot be here, but he asked that I deliver these remarks on his behalf.
We welcome this opportunity to contribute to the committee's study of issues surrounding the residential real estate market and home ownership.
As Canada's authority on housing, CMHC continuously monitors housing markets and undertakes research and analysis to support informed policy and decision making. This is key to fulfilling our legislative mandate to facilitate access to housing and contribute to the stability of Canada's financial system.
A robust statistical modelling exercise undertaken last year by our housing market analysis team confirms that the most important factors accounting for house price increases over the long term are economic in nature: rising disposable incomes, increased inflows of people, and lower mortgage rates.
Three additional factors are contributing to the shorter term price dynamics that are currently being felt in certain urban centres, notably Toronto and Vancouver. These include financial acceleration effects from both domestic and foreign investments and the implications of rising income and wealth inequalities. In regard to the latter, people with higher incomes can get larger mortgages and buy bigger, more luxurious homes. Coincident with increased income inequality in Toronto and Vancouver, price increases in these cities in recent years have been led by more expensive single detached homes.
Perhaps an even larger factor impacting house prices in some markets is the weak and lagging supply response. Geographic constraints in Toronto and Vancouver, as well as municipal land use regulation fees and extended approval processes, are limiting new construction and pushing home prices higher. It is clear that more supply would moderate price increases and alleviate the challenge this represents to home ownership.
At 69%, Canada's home ownership rate is among the highest in the world, and that includes countries such as the U.S., the U.K., France, Australia, and many other OECD countries. Although more work needs to be done, research from other countries supports the premise that home ownership is associated with positive social and economic outcomes, such as improved education results, greater community engagement, and wealth accumulation. I should caution, however, that much of the research predates the last financial crisis.
There is growing concern that escalating prices are putting home ownership out of reach for many Canadians, including young, middle-income families. This has potential implications, not only for these families, but also for the wider economy. For example, high housing costs may provide an economic incentive for workers to resist moving from less productive economies to more productive ones. This is a very human reaction that results in a significant net loss to the country as a whole.
CMHC has a mandate to facilitate access to housing, including by supporting the efficient functioning of the housing finance market to enable home ownership, but also to contribute to the stability of the financial system. In pursuing these objectives, we must be careful not to facilitate Canadians' buying homes they may not be able to afford.
Household debt is at a record level in Canada at 165% of disposable income, and residential mortgages account for about 72% of consumer debt. Our colleagues at the Bank of Canada continue to flag this as a top vulnerability to financial stability in Canada.
Concerns have been voiced about the ability of first-time homebuyers to buy homes. Support should not be unlimited, however. Ample support exists for first-time homebuyers, including the federal government's homebuyers' plan, federally guaranteed mortgage insurance itself, and various provincial measures. Too much encouragement to buy a home exposes vulnerable people to excessive financial risk, and pushes prices higher where supply inelasticity exists, making sellers better off, but not buyers, and jeopardizes our economic prospects. The last thing we want is for somebody to lose their home.
CMHC's most recent housing market assessment report, released just days ago, confirms that there is good reason for concern about housing market conditions. It indicates strong evidence of problematic housing market conditions in Canada as a whole. This was first noted in our fall 2016 housing market assessment. Since then, conditions have worsened in Victoria, although evidence shows problematic conditions have eased in Calgary.
We have, therefore, supported the Minister of Finance's efforts to rein in excessive housing market activities in our role as the government's policy adviser on housing.
Last fall, the Government of Canada tightened the eligibility rules for insured mortgages to reinforce the Canadian housing finance system and to help protect the long-term financial security of borrowers and all Canadians.
These changes addressed rather a chorus of commentary, from the IMF and OECD among others, that the federal government carried too much exposure in housing markets.
Notably, a “stress test” has been introduced for all insured mortgages. The Bank of Canada posted rate, which is typically higher than contract rates, must now be used to underwrite all guaranteed mortgages. This buffer will help offset the highly stimulative effect of low interest rates.
Secondly, while lenders are free to offer more flexible terms for uninsured mortgages, government-backed mortgage insurance will no longer be available for any mortgages on properties valued above $1 million or with amortizations beyond 25 years.
We expect these macroprudential policy changes will moderate demand for housing, which will have the effect of limiting price increases, making houses more affordable, and support sustainable economic growth.
We have observed modest reductions in activity, but it is too early to say whether the changes are in fact achieving these objectives. The spring season, which is typically very busy for housing markets, will help confirm any long-term trends.
Finance Minister Morneau has also initiated a public consultation on lender risk sharing for government-backed insured mortgages, which wraps up at the end of February. We look forward to exploring this idea, which we believe would result in a more resilient housing system by more fully involving lender in risk management and adjudication.
Currently, regulated lenders do not have to hold capital for risks associated with guaranteed mortgages. We are concerned about the misalignment of interests that could result, even to the extent of moral hazard in such cases.
Lender risk sharing aims to rebalance risk in the housing finance system by requiring lenders to bear a modest portion of loan losses on any insured mortgage that defaults. This will ensure that the incentives of all parties to an insured mortgage loan are aligned toward managing housing risks and further strengthening Canada's housing market and financial systems.
At CMHC, we estimate that a modest level of lender risk sharing could increase the typical five-year fixed rate mortgage by 10 to 40 basis points, depending on the default risk of a particular mortgage.
As a crown corporation with a mandate to contribute to Canada's financial stability, CMHC must be a leader in housing risk management. We have significantly strengthened our risk management policies and practices recently, and we will continue to do so.
In the interest of accountability, we have been deliberately more transparent and open in our reporting, analyses, and public presence. We are therefore grateful for the opportunity to be here and to support your work.
Thank you.
Liberal
The Chair Liberal Wayne Easter
Thank you very much, Michel.
Turning then to the Office of the Superintendent of Financial Institutions, we have Carolyn Rogers, assistant superintendent; and Judy Cameron, senior director, legislation, approvals and strategic policy.
The floor is yours.
Carolyn, go ahead.
Carolyn Rogers Assistant Superintendent, Regulation Sector, Office of the Superintendent of Financial Institutions
Thank you, Mr. Chair.
Thank you, on behalf of the superintendent and the rest of my colleagues at OSFI, for the invitation to be here today.
The health of the housing sector is important to the Canadian economy and to the health of Canada's financial sector, and we welcome the opportunity to participate in the committee's deliberations.
OSFI is Canada's prudential regulator and supervisor of federally regulated financial institutions. Our oversight includes banks, insurance and trust companies, and private pension plans. Approximately 80% of the mortgages issued in Canada are held by financial institutions under OSFI's supervision, and residential mortgages represent almost 30% of the assets held by the banks we supervise. Our responsibilities also include the monitoring and examination of the three mortgage insurers operating in Canada, including my colleagues from CMHC. Accordingly, OSFI keeps a close eye on the risks impacting the mortgage market, such as underwriting and risk management practices of lenders and mortgage insurers, as well as the broader risks, including economic conditions and the interest rate environment. OSFI's mandate is to protect the depositors, policyholders, and creditors of the institutions we supervise, while allowing them to compete and take reasonable risks.
At a policy level, OSFI fulfills this mandate through two key activities: setting principles and standards for sound risk management in financial institutions in the form of guidelines and other policy directives, and setting the minimum requirements for the quantity and quality of capital that financial institutions must hold.
OSFI's expectations with respect to risk management practices in the residential mortgage market are made clear in two separate policy guidelines: B-20, which sets out the principles for mortgage lenders, and B-21, which sets out the principles for mortgage insurers.
Minimum capital requirements for banks and insurers are evaluated by OSFI on an ongoing basis and are designed to ensure that lenders and insurers have sufficient capacity to absorb severe but plausible losses.
At an operational level, OSFI fulfills its mandate through a rigorous supervisory regime that combines continual monitoring and an examination process that ensures financial institutions comply with our guidelines and continue to hold capital and liquidity given their respective risk profiles.
Like all financial regulators, OSFI has worked hard in recent years to incorporate the lessons of the financial crisis in our policies and practices. Key among these lessons was that the vulnerabilities that build up in the residential mortgage markets, such as stretched housing valuations and high rates of consumer debt, can lead to financial instability and sharp contractions in economic activity. Deteriorating lending standards of lenders and insurers, and financing structures with misaligned incentives, can fuel these vulnerabilities.
Since the financial crisis, OSFI has made a range of adjustments to both our policy guidelines and our capital requirements for mortgage lenders and insurers. These adjustments reflect the lessons we've learned and the vulnerabilities evident in the Canadian market. Recent examples of these changes include requirements for certain mortgage lenders to hold additional capital for mortgages that originated in markets where housing price increases are significantly outpacing income levels. We've also recently adjusted the formulae mortgage insurers must use to calculate the capital, to incorporate a wider set of risk indicators.
In addition to policy changes, OSFI has increased its supervisory intensity of mortgage lending and tightened our expectations around mortgage underwriting practices. Most recently, just this past summer, OSFI issued a letter to the industry reminding them not to be overreliant on the collateral value of housing assets and to be diligent in assessing a borrower's willingness and ability to make payments on a timely basis. This letter was followed up by a series of targeted examinations.
These are just a few examples of OSFI's work with regulated entities designed to promote prudent mortgage lending and insurance practices, thereby increasing the resilience of Canadian financial institutions to adverse shocks and ensuring they are prepared for the unexpected.
Before I conclude, I would add that while OSFI is an independent regulatory agency, it does not operate in isolation. At the federal level, OSFI co-operates with key agencies, notably the Department of Finance, my colleagues here from the Bank of Canada, the Financial Consumer Agency, and the Canada Deposit Insurance Corporation. Although each of us has a distinct mandate, role, and focus, we all work in coordination to maintain a strong and stable financial system, a system in which Canadians can place their trust.
Thank you for your time. I look forward to your questions.
Liberal
The Chair Liberal Wayne Easter
Thank you, all, for your presentations.
Before we go to questions, Ron, did you still want to raise that point?
January 30th, 2017 / 3:55 p.m.
Conservative
Ron Liepert Conservative Calgary Signal Hill, AB
Yes, Mr. Chair. I understand that the CEO of the Canada Mortgage and Housing Corporation had a family emergency and couldn't be here today, but I do think it's critical for this study that we have him appear before the committee. I know, from talking to other committee members and with the clerk, it was quite a challenge getting folks scheduled to appear before this committee. I would like to propose that we set aside at least one more day to hear witnesses, and hopefully we can get the CEO to appear at that time.
Liberal
The Chair Liberal Wayne Easter
I do know the CEO had a family emergency. That's understandable, and there's no criticism there.
I think we had talked earlier as well with some of the members on our side, and it seems that due to the demand we're getting for witnesses for this study, we will be holding two four-hour sessions, but we will likely have to hold at least one more, if not two. I think we can agree that we will hold at least one more hearing. We'll talk about this at the steering committee to see how we will finalize it, if that's okay.
We may not expect another brief, but if the CEO is here to answer any further questions that might come up, that would be fine. That's the way we'll try to proceed.
We'll turn now to questions.
Mr. Sorbara, for seven minutes.
Liberal
Francesco Sorbara Liberal Vaughan—Woodbridge, ON
Thank you, Mr. Chair.
It's good to be back at work in Parliament again. Let me start with a little dialogue with everyone. I've taken the time to read the FSR report of December and June, and the comments of Mr. Siddall from CMHC from Vancouver and from London, and the CMHA report. I take an interest in OSFI's work all the time, because it was part of my past life.
Mr. Rudin's speech on sound residential mortgage underwriting in a changing environment, delivered on November 28, 2016, plus his remarks on bank capital, was interesting, along with all of our government's actions with regard to the housing market.
I look at this and I ask myself what worries me. If I can use a term from a book, where is the black swan? Is there one out there, and can we even identify it? Usually you can't until it's passed. What may trigger some sort of event in our housing market?
I look at what happened in the United States. We don't have NINJA loans; we don't have adjustable-rate mortgages; we don't have the large subprime market that they had. Our underwriting standards are top-notch, but we have household indebtedness. We have housing market imbalances due to the supply side, and we have a lot of regulatory change that is happening. So when I look at it, I ask myself what event out there may cause trouble for us and what exogenous event even more so. It could be a regulatory event in consequence of a regulatory action, and it's the exogenous side that scares me.
The simplest one that comes to mind is employment, or some sort of employment shock to the system, and you will see it in auto delinquencies or housing delinquencies. But we know that Canadians pay their bills. We are the best consumers in the world, basically. You can look at the data. I saw it in my past life and I follow it currently.
I look at the Canadian housing market, and we are regional markets. Measures that are introduced nationally may have unintended consequences in some markets. Toronto and Winnipeg are two different housing markets. I would argue that the housing markets in Toronto and Vancouver are like those in London and New York City 20 to 30 years ago, in which a million-dollar purchase price, which is not covered by an insured loan anymore, is just a million-dollar purchase price. The dream of having a backyard isn't there. You have to move to the suburbs.
A lot of the actions our government has taken pertain strictly to the insured market, which is 20% of the mortgage market, while 80% of the mortgage market is conventional. Please correct me if I'm wrong, but 20% is insured and 80% is conventional, uninsured. The housing price equation is not being driven by the first-time buyer; it's being driven by the conventional buyer, i.e., the low-ratio buyer.
In terms of the housing price equation, to me it's the housing market imbalances that are of greater concern, the supply factor, not the first-time buyer. That's one thing. My question, in a roundabout way, is what concerns us? I understand that financial stability is important. Since 2008 we've introduced a ton of measures—B-20 and B-21 and so forth. The new higher CMHC premiums for mortgage insurance came out earlier this week.
Mr. Tremblay, sir, risk sharing is a bad idea. It's going to result, in some mortgage markets in Canada, in consumers being dinged 30 to 50 basis points, especially in areas where economic growth is not as buoyant as in other areas.
I'm going to stop there. There are three minutes for remarks. I can go on for an hour on this thing, as you can tell.
I'm going to leave it there, but what black swan should we be worried about that is concerning for the Canadian housing market? Leave yourselves 45 seconds each.
Liberal
The Chair Liberal Wayne Easter
We're going to give you a little more time than that.
Who wants to start?
Deputy Governor, Bank of Canada
I'll start.
I'm not sure my swan is going to be as black as you want. One of the things we've been worried about in the risk scenario that we have in the FSR is really this idea that you could have another recession in Canada, an increase in the unemployment rate at the national level, which could impose stress on highly indebted households, with their having difficulties in making payments potentially, as well as stress on the financial sector as a whole.
We think this probability is still very low at this point, but as I said before, if this risk were to materialize, the impact would be substantial.
The other thing we've highlighted is that term premiums on interest rates are very low right now and we've had risk retrenchment over the past two years associated, for instance, with developments in China. It could be that we will have similar events in the future, with term premiums rising, pushing up interest rates and mortgage rates as a result. That's one of those scenarios that are a bit more difficult to predict because they involve confidence and risk aversion. This maybe speaks a little to your black swan.
Liberal
Francesco Sorbara Liberal Vaughan—Woodbridge, ON
We've also had a backup in global bond yields since the new president was elected, and prior to that, of about 50 basis points. My concern is that the employment verification, collateral verification, should also be added.
Deputy Governor, Bank of Canada
Yes, we've noted that in our latest monetary policy decision, this backup in bond yields. I think this situation might be slightly different in part because this seems to be driven by expectations of future growth in the U.S., maybe because of fiscal policy and higher inflation expectations. It may be more driven at this point by fundamentals and just a retrenchment of risk appetite, but....
Senior Vice-President, Policy, Research and Public Affairs, Canada Mortgage and Housing Corporation
With respect to lender risk sharing, that is why there's a consultation going on. It's to make sure that the government—the Department of Finance in particular—considers all impacts to the system. We are looking at that. I'm sure they're going to get some good feedback on that.
Assistant Superintendent, Regulation Sector, Office of the Superintendent of Financial Institutions
What I would add is in relation to your comment about the nature of our regional markets. I would say that the policies that OSFI has introduced around residential mortgage lending are regionally neutral. A good loan is a good loan regardless of where it's written. It has appropriate serviceability, it doesn't over-rely on collateral, and it takes account of the borrower's capacity—all of those things.
I think the fact there are externalities and issues that are unique to some of the housing markets in Canada is true, but I think that underwriting sound risk management and capital-reserving appropriate for risk is pretty universal.
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
Thank you, Mr. Chair.
Thank you to all our witnesses both for the work you do every day on behalf of Canadians and for your appearance and your expertise here today.
I'd like to start by saying first that there are a lot of concerns in my area. I'm from British Columbia. Obviously, I've had people throughout my riding who felt they were on a good path towards home ownership, particularly young Canadians, but because of these rule changes, that's been pushed back. I understand some of what you've said today, but I think most of us would agree that home ownership has served Canadians quite well. It is a place where people can store away equity over the long term. I think we should be very cautious before there are any future changes, as we heard in our pre-budget consultations. Time after time, we heard from credit unions and others that these changes need to be digested further.
I'd like to start with a question about these changes enacted by the government. Were they enacted under the Canada Mortgage and Housing Corporation Act? Is that where their authority came from?
Senior Vice-President, Policy, Research and Public Affairs, Canada Mortgage and Housing Corporation
Not to my knowledge, no. I think they're under the legislative power of the Department of Finance.
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
Okay. The reason I ask is that obviously there's not a “Canadian” real estate market. There are hundreds of real estate markets, some small and some large, and obviously these changes really seem to be constructed to deal with some issues that are specific to places such as Toronto, or Vancouver in my home province.
The question I would have, besides noting what some mortgage lenders have described to me as applying a sledgehammer to a very specific problem, is this: were there tools that the government ignored using in order to be able to apply some of these changes to regions rather than nationally in scope? Can anyone give some inkling of an idea as to whether or not that would have been more appropriate?
Deputy Governor, Bank of Canada
I'm not going to comment on the tools per se, but in terms of the impact across cities and across regions, we've done some work on this in looking at who would be impacted and which cities would be impacted. What we found is that not only the GVA and the GTA are impacted, but a host of cities are impacted. That's because the measures have different requirements in terms of people's ability to repay their debt. There's a requirement in terms of mortgage debt but also in terms of total debt.
It turns out that there are highly indebted households in many different parts of the country. For instance, in Montreal and Halifax house prices are low, but consumer debt is very high, so those folks are being impacted by the measures. This thing is a bit broader, if you want.... It's really, in a sense, about targeting it and having an impact on total indebtedness, not only on mortgage debt.
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
But I think we should also note that this basically does prohibit certain people from being able to get a home and to get into it. That's really what this is doing; it's pushing that back further. We can spin it however we want, but the fact is, we're not allowing people to get into debt because we're not allowing them to get into a home. Is that not correct?
Deputy Governor, Bank of Canada
No, that has this impact. At the same time we want to make sure that people who are buying homes are resilient to future shocks, so this comes as a stress test. We completely agree that this has the impact of reducing demand at the margin. But again, we don't want people to get into loans they cannot repay.