Canada should be bracing itself for the reality that house prices are more likely to go down than up in the next few years, says former Bank of Canada governor David Dodge.
He is not taking sides in the simmering debate about whether there is a housing bubble in this country, noting that policy-makers are still struggling with a long-standing dilemma: you don't know a bubble until it bursts.
What he is saying is that prices are certainly strong enough that it would be wise for Ottawa to take action.
"These prices look pretty high by any conventional measure," he said in an interview, citing measures such as the ratio of house prices to incomes and rents to house prices. "So, the likelihood of house prices falling a bit over the next few years is probably somewhat greater than that they would rise over the next few years."
"Whether there's a bubble or not you can only see after the fact," he added. But it wouldn't take a bubble bursting to cause consumers pain. If your house price goes down 10 per cent and you've borrowed 95 per cent of its value, all of a sudden you'd be in hot water, Mr. Dodge noted.
His comments come as Ottawa weighs action to take a bit of steam out of the housing market. While the government does not believe there is a bubble, it has been evaluating tools it could use to help ensure that more consumers don't take on mortgages they won't be able to afford when interest rates rise or if house prices fall.
The worst scenario would be if both of those things occur at once. Consumers would find themselves with higher monthly mortgage payments and less valuable homes.
While it's virtually assured that interest rates will rise at some point, Mr. Dodge is of the view that it's also realistic to assume house prices will fall. He notes that mortgage rates are likely to rise, which will put a damper on the market. Secondly, "we're probably into a fairly long period of relatively slow income growth," he said, and that too will curtail some housing activity.
While it's clear that low interest rates are heating up the market, it would not be wise to raise them just in order to calm housing because such a move would have other consequences, Mr. Dodge said.
"Hence, you've got to look at lending standards and the framework for mortgage insurance as very important tools of stabilization," he said. "The terms and insurance over which mortgage insurance should be given over the next little while probably should be tighter, and probably should have been tighter over the past period."
Mr. Dodge said he has never been comfortable with the idea that people can buy homes with down-payments of as little as five per cent. Whether increasing it to 7.5 per cent or 10 per cent, he would be supportive of raising the minimum payment.
He added that it would be possible for Canada Mortgage and Housing Corp. to rein in the market on its own, without an official move by government, by tightening the requirements for mortgage insurance. That's what the Crown corporation used to do when he worked there in the "old days" (the 1970s), he said. For instance, it could tell banks that in order for a mortgage borrower to qualify for insurance, even if they're just getting a three-year variable rate mortgage, they have to be evaluated to ensure that they could afford a five-year rate on a mortgage with a 25-year amortization.
The Crown corporation is currently looking at such options, according to sources.
CMHC's "actual mandate today, which is different from what it was back 20 or 30 years ago, is really just to get people into houses," Mr. Dodge said. "And that's always been something that bothers me, because it really doesn't have a stability mandate."
He suggested that it would be wise for Ottawa to officially give CMHC a mandate to watch over the health of the housing market.
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