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Desperately Resorting to Credit Rationing

Desperately Resorting to Credit Rationing
Profile photo of George Bragues

Clearly, the federal government does not want the Bank of Canada (BoC) to raise interest rates. Yet it also realizes that Mark Carney, the governor of the BoC, is correct in worrying about the growing debt that’s been taken on by Canadian households. So it’s trying to finesse these two considerations – hence, Jim Flaherty’s announcement today of various measures to restrict mortgage lending. The Finance Minister’s gambit is flawed.

Mr. Flaherty announced today that the government will reduce the maximum allowable amortization period on mortgages from 35 to 30 years on loans insured by the Canada Housing and Mortgage Corporation (CHMC). The CHMC is a crown corporation that insures residential mortgages in which the borrower puts down less than 20% of the value of the home. The Finance Minister also indicated that the government will lower to 85% of a home’s value, from 90%, the amount that borrowers can refinance. Finally, the government will no longer be insuring lines of credit collateralized by people’s houses.

One can, of course, raise the question why the government is in the business of insuring mortgages at all. The private sector can perform this role while incurring less moral hazard of incentivizing the banks to issue mortgages to high risk borrowers. As matters currently stand, should Canada’s housing market collapse, the CHMC is liable of running into solvency problems, just like Fannie Mae and Freddie Mac did in the United States.

Setting this issue aside, we shouldn’t forget that this is not the first time that the government is attempting to cool real estate borrowing by tightening lending standards. It took action both in October 2008 and April 2010. Neither of these moves worked. Debt levels continued to rise. And there’s nothing unique to these latest measures to suggest that the government’s credit rationing approach will suddenly succeed.

More importantly, the government is wrongly assuming that the real estate market is the only arena in which low interest rates are threatening to create an unsustainable boom. Artificially low interest rates generate distortions across the entire economy. To be sure, as the Austrian tradition points out, this dynamic tends to be concentrated in long-term assets like housing. But the economy is full of industries in which the returns on current outlays only accrue well into the future. These are the sorts of projects that get oversubscribed with excessively low interest rates. In Canada, the most obvious candidates for this malinvestment, other than real estate, are the commodity and resource extraction sectors.

The government cannot have it both ways. The BoC needs to raise rates. It ought to start tomorrow with its latest monetary policy report.

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Profile photo of George Bragues

George Bragues teaches Business at the University of Guelph-Humber in Toronto, Canada.

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