Restraining the housing market may be wise but it remains divisive: Don Pittis

It's pretty clear that theexplosive growth in the price of Canadian houses over the last decadewas the inadvertent product of an emergencyplan to rescue globalcapitalism in 2008.

There's more evidence of that in anew book,Firefighting: The Financial Crisis and Its Lessons,published this weekby former U.S. Federal Reserve chair Ben Bernankeand two other architects of the rescue plan.

And despite the factit iswidely accepted thatCanadian house prices did not need a boost in 2008, a new CIBC reportis a reminder of the ambivalence of even the most staid economists over governmentattempts to withdraw stimulus from the real estate sector after a decade of overheating.

Bernanke's new booklays outthe case that whencentral banks around the world cut interest rates following the 2008 credit crunch, the purpose was to prevent no less than the devastation of anotherGreat Depression.

"We helped shape the American and international response to a conflagration that choked off global credit, ravaged global finance, and plunged the Americaneconomy into the most damaging recession since the bread lines and shantytowns of the 1930s," reads the book's introduction.

Critics of the Monday morning quarterback variety have since complained that the schemewhich involved slashing interest rates to zero and bailing out banks to the tune ofhundreds of billions of U.S. dollarsmerely perpetuated a problem created by irresponsible lending.

But while the current state of the U.S. economy offers evidence thatBernankeand the othersmay have got it right, there are clear signs that holding interest rates so far below levelsthe market would otherwise demand has led to a number of distortions.

The U.S. housing market, shattered by the collapse of the subprime lending boom at the heart of the 2008 meltdown, plainly needed the stimulation of low rates. That was not so inplaces like Canada and Australia, where housing markets were already hot and hadn't crashed.

In an integratedglobal market, unfortunately, the independence of the Canadian central bank is relative.

Ifthen Bank of Canada governor Mark Carneyhad tried to hold rates above four per cent while the Fed was cutting to just above zero, disruptions to the Canadian economy would likely have been fatal.

In retrospect, the disruptive effect on Canada's housing market seems obvious. In the heat of the moment, it must have appeared that a little stimulation in the housing market would be positive, encouraging construction and putting money into the hands of existing homeowners.

Stimulus needed?

It soon became obvious that low interest rates had created a Canadian home ownership monster, with prices in some places at one point rising somewhere near 30 per centin a single year.

Unless you already owned one, houses became unaffordable for manyCanadians.

Foreign buyers, liking those shocking rates of return in a safe and stable economy, bid the market up further. Those Canadians who wanted to compete had to sign on to mortgages that sucked up most of their income.

And all the while, people like Stephen Poloz, Carney's successor at the Bank of Canada, began to worry that a housing bubble was forming andat some pointwould pop, spreading pain across the economy.

When it comes to the Bank of Canada'sinterest rate, Polozhas his hands tied now, just as much asCarney once did. He can stray slightly from the path of U.S. interest rates but not too far.

The bank's solution instead has been to use something called "macroprudential"tools, effectively leaving interest rates low to stimulate the broader economy, but using mortgage stress tests to restrainstimulation of the housing market.

The consumer friendly way the planhas been sold is that if prices do start to fall, or if interest rates begin to rise back to historic levels, young homeowners saddled with a 30-year mortgage commitment will not be overwhelmed by debt or lose their houses.

It also prevents Canadian banks from getting themselves into trouble by lending to people who may default in future.

'But the patient died'

Generally the big banks have been supportive of the stress tests.But CIBCreleased a reporton Tuesdaywith the cheeky title "Mortgage Stress Test: The operation was a success, but..."

For those who don't recognize it, the concluding part of that phrase usually is "the patient died."

If you examine the reportyourselffor itssubtleties, you'll see that CIBC economist Benjamin Taloffers some arguments for and against stress tests. But the nub of hiscase is that the stress test should be watered down.

The testwhich forces borrowers to show they have enough income to cover a two-percentage-point increase in interest rateshas led to a decline in new mortgages and a move toward alternative sources of funding, including families, says Tal.

At the same time, of course, house prices are falling from their most astronomical heights, which hasmany people inthe real estate sector ready to blame governmentfor the decline.

But would Polozsupport rollingback those stress tests when he speaks next Wednesday?Despite the case made by the CIBCreport, there are reasons why he may not.

Even with the reported decline in mortgage borrowing, Canadians are still mired in debt that is growing faster than income.

While home sales are falling just now, a mortgage commitment lastsdecades. So while the economy may continue to come up roses, asudden recessionsomethingmany have predicted could abruptlynix a young couple's repayment plans, getting them into serious trouble.

One reason many scoff at those short-sellers who have bet against Canadian banks is that they saythe Canadian government will do its bestto ensure they stay sound. The stress test does that.

And, as in 2008, the globaleconomy may still need continued low interest ratesto keep it healthy. That's what our central bankers are telling us. But house prices?

Even if the market is cooling off a little just now,Canadian houseshave risen in value far beyond the level of any other consumerasset over the last decade, making them almost unaffordable for Canadians earning an average wage.

Maybe, as in 2008, the housing marketdoesn't really need a full dose ofstimulus.

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