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The Globe and Mail

The Flaherty-Dickson-Carney debt balancing act

The decisions of Bank of Montreal and Manulife to post aggressively low mortgage rates have upset the country’s economic balance.


Jim Flaherty is not an economist, but everyone I've ever asked about his approach to policy-making says he's an extremely diligent student. He absorbs his briefing material like a sponge, is a prodigious note taker and consults broadly. Then he makes a decision and sticks with it.

Mr. Flaherty's attempts to influence posted mortgage rates at Bank of Montreal and Manulife Bank show he's learned the lessons of the financial crisis.

Former Federal Reserve chairman Alan Greenspan's experiment with unusually low interest rates for an unusually long period of time lit a bonfire in the housing market. But instead of lining up buckets of water, U.S. president George W. Bush and his economic officials danced about the flames hooting and cheering. The national home ownership rate surged to roughly 69 per cent in the years ahead of the crisis, from about 67 per cent in 2000. (Even that rate was high; before 1997, the national home ownership rate tended to top out at around 65 per cent, according to U.S. Census Bureau data going back to 1965.) The Bush White House took this as evidence that its "ownership philosophy" was working, and encouraged Americans to get on board.

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Mr. Flaherty clearly is unwilling to repeat that mistake.

Interest rates in Canada have been exceptionally low for an exceptionally long period of time, reflecting an economy that is struggling to eke out growth of a meagre annual rate of 2 per cent. In all likelihood, borrowing costs will remain historically low for at least another couple of years.

But unlike the Great Moderation, when policy makers started to believe they had conquered the business cycle, the current experiment with ultra-low interest rates is born of necessity. The authorities in Ottawa lit a bonfire of their own in the housing market to ward off an economic deep freeze.

They no doubt hoped that the global economy would quickly right itself, and policy could return to a more normal setting. That didn't happen, so Ottawa has had to improvise. It started with Bank of Canada Governor Mark Carney and Mr. Flaherty warning repeatedly about the perils of household debt. Mr. Flaherty on four occasions tightened mortgage standards. Julie Dickson, the superintendent of financial institutions, ordered lenders to tighten their underwiritng standards.

Their efforts represent a novel approach to policy-making that departs from pre-crisis thinking that put the central bank at the centre of macro-economic policy. By aggressively applying moral suasion, and attempting to cool the housing market through regulation, the hope is a financial crisis can be forestalled, allowing the central bank to keep borrowing costs low.

It's a delicate balancing act, but there's reason to believe Mr. Carney, Ms. Dickson and Mr. Flaherty may have pulled it off. The Bank of Canada in its last policy statement stopped suggesting that it might need to raise rates to persuade households against taking on more debt.

The decisions of Bank of Montreal and Manulife to post aggressively low mortgage rates upset this balance – the equivalent of throwing fuel on flames that only just have been brought under control.

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Mr. Flaherty's has been compared to a finance minister from a banana republic, and has been called anti-competitive.

The first charge is ridiculous, as Mr. Flaherty's actions are consistent with Ottawa's post-crisis policy, which actually is rather sophisticated. As for the second, any who make it should remember that virtually all those loans that Canada's banks are so eager to give away are backed by the government.

The financial industry is an out-sized beneficiary of Canadian economic policy. Ownership rules protect the banks from foreign competition, and they have earned billions by issuing what are essentially risk-free loans. Given this arrangement, Mr. Flaherty, as underwriter, is allowed an opinion on how lenders conduct their business.

If anyone understands this, it's the executives at Manulife, who, when they're not dishing out home loans, run one of the world's bigger insurance companies.

Editor's note: An earlier online version of this story incorrectly stated that Julie Dickson, the superintendent of financial institutions, ordered lenders to hold more capital against their massive portfolios of home loans. This online version has been corrected.

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