This story was originally published in March of 2013.
Ottawa's latest intervention in the residential mortgage arena – persuading Manulife Bank to quickly abandon its offer of ultra-low five-year fixed mortgages at 2.89 per cent – may strike many as a step too far, an excessive intrusion by government into what should be a competitive market.
Certainly, there are reasons to see this as a disturbing move, particularly after Finance Minister Jim Flaherty effectively warned off other lenders from following Bank of Montreal's lead when it dropped its five-year rate to 2.99 per cent this month. The Finance Minister was never intended to be the nation's rate-setter-in-chief. If the market can bear interest rates of less than 3 per cent, the intrusion by Mr. Flaherty amounts to the government asking banks to overcharge customers.
But put yourself in his shoes. For some time, Mr. Flaherty has been preoccupied by Canadians' worrisome penchant for borrowing. The ratio of household debt to personal disposable income recently hit 165 per cent, up from 137.8 per cent in pre-crisis 2007 and just 86.5 per cent in 1990. Despite steps by the Finance Department to cool the housing market, a Moody's Investors Service report this month highlighted Canada as having one of the most overheated housing markets among 17 developed nations.
With sales levels dropping in recent months and prices predicted to drift gently downward (they've recently been flat, with the exception of downward-bound Vancouver), the housing market looked set for the kind of soft landing Mr. Flaherty wanted – until the threat of a mortgage-rate war surfaced. That's when he decided to use his bully pulpit to intervene in the market – and for reasons that are quite understandable.
To be sure, the efforts by BMO and Manulife to entice prospective buyers were entirely legal and made perfect business sense. With the market softening, their mortgage departments needed to work harder to keep customers coming in.
But from Mr. Flaherty's perspective, a mortgage-rate war threatened to turn Canada into a macroeconomic nightmare. Low rates would have enticed Canadians to further extend themselves at a time when international observers, including the Organization for Economic Co-operation and Development, are warning that the housing situation threatens Canada's financial stability.
Canada survived the last economic crisis better than most, but given our increased debt burden since then, that wouldn't necessarily be the case if there were another economic shock now.
"The Canadian economy would be much more vulnerable than it was in 2007," said Craig Alexander, chief economist with Toronto-Dominion Bank. Soaring unemployment or fast-rising interest rates could squeeze incomes, leaving Canadians with less to spend after meeting their mortgage obligations. Given that consumer spending drives close to two-thirds of gross domestic product, it's understandable why the Finance Minister continues to play nervous nanny to the economy.
There's another reason, of course, for Mr. Flaherty's concern: Canadian lenders are largely shielded from mortgage-loan losses by mortgage insurance, most of which is provided by the government's Canada Mortgage and Housing Corp. While Ottawa has taken steps to tighten lending practices, it's ultimately on the hook for all that insurance – close to $600-billion-worth as of the end of 2011, equal to one-third of GDP.
"Government backing of a large portion of bank assets helped importantly to maintain the system's stability during the crisis but also implies that public finances may be exposed in the event of a major shock to housing markets," the OECD said in a report on Canada last June. Lenders have long benefited from this arrangement. No doubt Manulife got an earful from Ottawa about that as well.