Flaherty moves to put brakes on consumer debt

Share

Facing the possibility of interest-rate increases during an election campaign and growing worries about consumer debt, Finance Minister Jim Flaherty moved again to unwind some of the riskier mortgage schemes he once sanctioned and encouraged.

As of March 18, the maximum amortization period for government-backed insured mortgages will drop to 30 years from 35. The government will also lower the maximum amount Canadians can borrow in refinancing their mortgages, to 85 per cent of the value of their homes from 90 per cent, and in April will pull government guarantees on lines of credit secured by homes.

By acting now to stop more Canadians from getting in over their heads with debts they won't be able to service, the government is putting political distance between itself and the central bank's inevitable - and inevitably unpopular - return to higher borrowing costs. At the same time, the move gives Bank of Canada Governor Mark Carney added flexibility to leave interest rates alone until he believes raising them is the right course for the economy as a whole, instead of risking economic damage for the sake of a small subset of borrowers.

Mr. Flaherty's decision also allows the government to separate the issue from a federal budget that could serve as the blueprint for an election campaign just weeks later.

Opposition parties' reaction to the measures suggests the government would be wise to neutralize the debt issue now, lest a possible spring campaign be peppered with reminders that the loose borrowing climate for the housing market was in part created by the Harper government.

Most economists say Mr. Carney, who will likely leave his benchmark interest rate at 1 per cent Tuesday morning, could be on hold until at least midyear, now that Mr. Flaherty has taken another crack at a problem the central bank sees as the No. 1 risk associated with having rates so low.

"There is a clear linkage between what Finance is doing and monetary policy," said Benjamin Tal, deputy chief economist at CIBC World Markets in Toronto. "If [Finance]didn't move, then Carney might have been more aggressive. So there is a linkage and the timing is maybe designed to separate the two and show there is no linkage, but there is.''

At a news conference in Ottawa, Mr. Flaherty said government policy aims to strike a balance between supporting the housing market and avoiding debt trouble.

By that, he was referring to the fact that his government already acted in 2008 to reduce the maximum government-backed mortgage from 40 years to 35 years, as well as introducing measures last year that made it harder to qualify for mortgages. On Monday, Mr. Flaherty indicated the government is particularly concerned about Canadians using home-backed lines of credit for frivolous purchases.

"Some of those loans are not used to create housing," he said. "They're used to buy boats and cars and big-screen TVs, things like that. And that's not the business that [mortgage]insurance was designed for."

The governing Conservatives are clearly attempting to use these moves to further their argument - highlighted again in new political ads this week - that only they can be trusted to be prudent managers of the economy. Yet by tying the party's brand so closely to Mr. Carney's warnings about consumer debt, the Conservatives may run the risk of negative associations as the Bank moves to lift rates.

Moreover, Mr. Flaherty's critics are quick to point out that his first budget stoked the conditions that allowed some borrowers to get in way over their heads.

The Conservatives came to power in early 2006, as the government's mortgage insurer - Canada Mortgage and Housing Corp. - was in a heated battle with new private-sector insurers from the United States. The competitive pressure saw CMHC lift the 25-year limit on the mortgages it was willing to insure all the way to 40 years over about nine months.

Mr. Flaherty's first budget doubled the amount of federal cash available to back private mortgage loans, "in order to keep pace with the increase in housing prices," and promised the measures would give consumers greater choice and promote home ownership.

"He has to take some responsibility for having contributed to this problem," said Liberal finance critic Scott Brison.

Pollster Nik Nanos said the political motivation for the Conservatives is to contain the potential for blowback from voters who will not be happy with future interest rate increases.

"There's a political risk in having the government, any government, closely associated with a high-interest rate policy," Mr. Nanos said "I think the Conservatives are looking to politically inoculate themselves."

The Bank of Canada chief and his officials have sharpened their warnings on debt over the past year, while strongly implying that they view narrowly tailored regulatory changes as more appropriate to deal with the issue than lifting borrowing costs throughout the economy.

As it became clearer late last summer that Mr. Carney might need to pause his rate increases for several months amid a slower-than-anticipated U.S. rebound, he ratcheted up his warnings on debt, detailing how the problem could spark a wider financial or economic crisis if left unchecked.

In December, Mr. Carney gave a speech and a number of media interviews to drive the point home, just days after releasing a review of the financial system that found household debt is the main domestic risk to Canada's economy. At the time, he all but said he was looking to Mr. Flaherty to heed his warnings, telling BNN, "These are not decisions for me to take."

That same month, as Mr. Flaherty looked to strike a balance between reining in debt and preventing the housing sector - a linchpin of the recovery's early stages - from slowing too sharply, the minister was warned by the Canadian Real Estate Association and Canadian Association of Accredited Mortgage Professionals that raising the current 5-per-cent minimum down payment would shut too many first-time buyers out of the market and cost jobs.

Mr. Flaherty opted against tinkering with down payments.

Economists said the narrower moves, which Mr. Tal called "surgical and precise," will have the desired effect of curbing the ambitions of a tiny minority of borrowers - and voters - without threatening the recovery.

"At the margin, they will lose some political points for this, because you're taking away something that people use," said Michael Gregory, a senior economist at BMO Nesbitt Burns Inc., referring to the clampdown on home-equity loans and longer amortizations. "But the political points are probably a lot less, now that the ground has really been softened up."

With a report from Steve Ladurantaye in Toronto