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In Toronto, average resale home prices have surged more than 17 per cent since the same period last year, while prices for detached houses jumped an annualized 18 per cent to $1.21-million.

Ian Willms/The Globe and Mail

Ottawa's new standard for gauging whether borrowers can handle higher interest rates to buy homes is necessary to prevent damaging the broader economy, says the head of Canada's housing agency.

Evan Siddall, chief executive officer of Canada Mortgage and Housing Corp., said he is concerned about warning signs in the country's housing market, especially in the Vancouver region and Greater Toronto Area.

"It's the combination of high house prices and high household debt. That combination of factors is not good for an economy and, in a lot cases, it ends up really harming the growth rate of the economy," Mr. Siddall said in an interview in the wake of CMHC's warning this week about problems in the real estate sector.

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Read more: CMHC issues 'red' alert as surging home prices spread to suburbs

Opinion: The intended consequences of new housing policies

Explainer: What you need to know about Ottawa's real-estate reform

CMHC will raise the risk rating in its assessment of the country's residential market as a whole in a report on Oct. 26, when it will issue a "red" warning to signal "strong evidence of problematic conditions" such as overvalued properties and prices that are rising too rapidly.

Mr. Siddall acknowledged that some first-time buyers will be priced out of the market because of Ottawa's "stress test," which critics say will reduce demand for housing because borrowers will qualify for lower mortgage amounts.

"It will affect a portion of first-time home buyers for sure. These are the people who are the most vulnerable. They are the people who have the least job security overall and most demands on their pocketbooks," Mr. Siddall said. "Encouraging them to save a little bit more money for a down payment or perhaps buying a smaller home – we think that's healthier for them. That means they will be less likely to face difficulties down the road to continue to afford their homes if something went wrong."

CMHC's general red alert in the federal agency's assessment of 15 metropolitan markets didn't happen overnight. In July, CMHC deemed Vancouver, Toronto, Calgary, Saskatoon and Regina as regional markets showing strong signs of problems. The other 10 markets were seen as facing weak or moderate risks for problem conditions in July, but viewing the country as a whole, the Crown corporation is now sounding the alarm about Canada's real estate sector.

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"Making policy at a national level for a bunch of different economic regions is challenging," Mr. Siddall said. "On housing policy in particular, the lead is the Department of Finance – Bill Morneau's department. We work week-to-week with them, all the time, exchanging information and ideas."

Mr. Siddall said CMHC itself has conducted an internal stress test under a scenario of a 30-per-cent decline in housing prices and a five-percentage-point jump in the unemployment rate. While the economic impacts would be severe, CMHC could withstand such shocks, he said.

The agency had $523-billion in outstanding insured mortgages as of June 30.

Critics say the federal government and CMHC have acted too aggressively in efforts to cool housing markets.

"If potential home buyers expect that house prices will fall, and decide not to buy as a result, then this can become a 'self-reinforcing expectation,' which is also dangerous for the market and the broader economy," economist Will Dunning said in a new report released Tuesday.

"If the weakened housing market causes consumers to expect (or fear) that house prices could fall, this would reduce housing demand, further impairing the economy," said Mr. Dunning, a consultant who is chief economist for Mortgage Professionals Canada, which represents brokers.

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He noted that mortgage applications are being stress-tested at a Bank of Canada interest rate posted at 4.64 per cent, which is well above rates available to consumers. Lenders are now offering 2.5 per cent or lower for five-year fixed terms.

If housing sales and starts drop sharply, property prices are bound to decrease and lead to the loss of thousands of construction jobs, Mr. Dunning said.

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