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Business Commentary What the feds should do about regional housing froth: nothing

Finn Poschmann is chief executive officer of the Atlantic Provinces Economic Council.

Canadian housing market analysts have had a common theme for years: Prices are overheating and, implicitly, a bust looms.

But is this true? And if it is, what are we to do about it? The answers are maybe, and probably nothing, if experience and theory are a guide.

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It is easy to make the case that the Canadian housing market is headed for a fall. At the national level, our Great Recession from late 2008 through early 2009 knocked out only 8.5 per cent of its stuffing. What's more, the previous peak had been recovered by late 2009 and aggregate prices since have marched steadily upward: March, 2016, established a new height.

For house prices in Canada's major centres, the 10-year compound average growth rate is 5.4 per cent and year over year, it's 7 per cent. That far exceeds our average income growth. This makes sensible analysts worry and so too does our persistently high consumer debt-to-income ratio, which sits in the neighbourhood of 160 per cent.

However, while domestic governments have been borrowing on the whole, and mostly digging deeper holes on behalf of their residents, Canadian households since early 2009 have steadily brought down their ratios of household debt to total assets. Debt isn't such a big problem if your assets far exceed it.

Of course, that fall in the debt-to-assets ratio is in part owing to the contemporaneous rise in average real estate prices. So the debt ratio's decline could be a bit of a mixed blessing, if a bust does arrive. More comforting is that our household debt service ratios – how much of your income it takes to cover interest only – are at record lows. Rising interest rates will change that, but not in the near to medium term.

And then there are the regional aspects.

Because of their sheer size and hotness, Vancouver and Toronto dominate the national data. Their annual house price growth rates over the past 10 years average 7 and 6 per cent, respectively – over the past year, a mindboggling 17 and 9 per cent.

Calgary is an interesting case. After a powerful oil-driven rise last decade, it was hit earliest and hardest in the recession. But it also bounded back smartly, reaching its all-time price peak in late 2014, by which time the oil market had again started to fall through the floor. Yet the Calgary market's battering has not been too brutal and the average price decline since fall 2014 is less than 6 per cent.

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Meanwhile, Ottawa and Montreal have been dead flat over the past year and, like Moncton and Halifax, had less of a run-up during relatively good times. And then there is oil-befuddled Newfoundland and Labrador, where housing starts have all but come to a stop. Which highlights only the howlingly obvious: that real estate markets are regional.

What, then, are federal policy makers, or the Bank of Canada, to do about the rather bubbly (on average) housing market?

Some of it has already been done, through legislative and regulatory changes that have made the federal mortgage insurer, Canada Mortgage and Housing Corp., more attuned to risk, which it used not to be. When CMHC is focusing on borrower risk and managing its own capital, the agency's smaller private competitors are better able to do so as well, while staying in business.

The other part of the puzzle is Bank of Canada interest rate-setting, which is stuck on low.

Should the bank change course specifically to address regional risks? This is an old question often asked and the simple answer is no. Canada can have only one Bank of Canada policy stance, so long as we are to remain a federal nation.

But what about on an aggregate level, when growth in large and hot neighbourhoods dramatically outstrips the rest of the market? The national figures are not wrong in reporting those bubbly totals – should the bank respond directly to them?

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In economics, this is known as the "lean or clean" question: whether a federal authority should lean against the housing price winds, or hold back, with an eye to cleaning up any messes that might arise.

My instinct is that it is difficult to know when exactly it is time to lean. For instance, when times look good, borrowers and lenders and regulators and legislators, all sharing similar information sets, will see little reason to lean against those good times. That is when bubbles form and we only find out for sure we were in one after they pop.

And then there are the costs of "leaning," addressed in a hot-off-the-press Bank of Canada working paper, conveniently titled Should Monetary Policy Lean Against Housing Market Booms?

The authors have an answer, too, and it's remarkably clear for theoretical work: No. The reason is that a central bank taking steps – raise interest rates – to reduce the likelihood of a bubble is a lot like insurance. Raising interest rates to prevent bubbles, under a practical set of assumptions, costs borrowers more than the insurance protection is potentially worth, making us less well off than otherwise.

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