If the Bank of Canada was permitted to do so, would it tighten home lending standards?
There's reason to wonder. The central bank said on Tuesday that it expects record household debt levels to keep rising.
In one way, that's good. With Europe's economy likely in recession and China's red-hot economy cooling to a more sustainable pace, domestic spending will continue to help Canada push through the current turbulence.
But it seems the Bank of Canada would be willing to forgo yet more debt-fuelled spending.
Policy makers made no mention of household debt in their previous statement. That's significant. Governor Mark Carney and his deputies have expressed concern about household debt in speeches, and they have made note of the risk in formal reports on the financial system. Now, policy makers are discussing Canadians' extreme debt levels in terms of setting policy for the broader economy. The threat level, as far as the Bank of Canada is concerned, is rising.
The prediction that household debt levels will continue to rise is an admission that Canadians are paying closer attention to the central bank's actions, rather than its words. Mr. Carney's increasingly severe warnings about the perils of debt last year apparently were no match for the once-in-a-lifetime allure of incredibly low mortgage rates.
This is why some academics argue that central banks should be given more power to fine-tune their policies.
Aside from public warnings, the Bank of Canada's only direct means to influence consumer behaviour is to raise interest rates. But doing so now would be a mistake because companies need to be encouraged to borrow and invest. Higher interest rates also would inflate the value of the dollar, which would cripple Canadian exporters that the Bank of Canada already considers to be broadly uncompetitive.
It could be argued that the commercial banks should act more responsibly. Don't count on it. Just as consumers have a powerful incentive to borrow, the banks have a powerful incentive to lend. It's mostly risk-free lending because the mortgages are insured by Canada Mortgage and Housing Corp. (CMHC). And no lender driven by the profit motive is going to turn down that opportunity unless it is forced to by the government. Just listen to Toronto-Dominion Bank chief executive officer Ed Clark:
"The reality is it's not like we don't offer 25-year amortization mortgages or 20-year amortization mortgages. People can pick their amortization periods. But if you offer them more choice, overwhelmingly they will choose the longer period, and so the question, is would one bank say, 'Well, I don't care what you want; we're going to only offer 20-year amortization mortgages,' while everyone else offers a 30-year amortization? We know what would happen – TD would no longer be issuing mortgages and everyone will go across the street. That's what the public has said by the way they act."
Mr. Clark made the comments during a discussion with former Bank of Canada Governor David Dodge last month in Toronto. (The event was a semi-private affair for clients. TD provided a transcript.)
Underlying the Bank of Canada's concern, Mr. Clark has said publicly that the maximum amortization period for home loans should be lowered to 25 years and that Ottawa should implement a qualifying rate, which would lower the default risk when official borrowing rates eventually rise.
The reason for doing so is to avoid the day when households realize en masse that they are overextended and must retrench. When this happens, the normal incentives to borrow and spend are ignored. In the U.S., consumers can get 30-year mortgages at rates of about 4 per cent – and they deduct the interest payments against their taxes. Yet half of TD's U.S. customers are choosing 15-year home loans, a sign that the recession has had a significant effect on consumer behaviour. That helps explain why the recovery has been so torturous. "That's what we don't want to go into, is where we get that collapse and then we have to dig our way out of it," Mr. Clark said at the December event.
Mr. Dodge explained the limits on the Bank of Canada's ability to deal with the issue on its own. He said low interest rates are necessary for the broader economy, but not for housing. However, it's CMHC and the Finance Department that sets the rules for housing. As with the public, the Bank of Canada can only sound the alarm. Action will depend on whether the politicians agree.
"This is a very judicious balancing act, and unfortunately it's the Bank of Canada on one side that does the monetary policy, and Canada Mortgage and the Department of Finance on the other side that does the regulation," Mr. Dodge said. "And that really does require much closer policy co-ordination between the three parties."