National Post (National Edition)
WHY DO WE HAVE MORTGAGE STRESS TESTS AGAIN? HAIDER-MORANIS BULLETIN,
Not intended to address price issue
Housing sales in Canada’s large cities continue to show signs of weakness. The latest stats for February sales in Toronto and Vancouver revealed even fewer sales last month than February 2018, when sales had already declined because of stricter mortgage regulations.
The real estate industry is holding the mortgage stress test responsible for the slowdown. The test requires borrowers to qualify for an interest rate that is 200 basis points higher than the contracted rate.
The proponents of the stress test believe it is working as intended and credit it for improving housing affordability resulting from the falling housing prices.
But here lies the problem. Unlike the proponents, the regulator which instituted the tests — the Office of the Superintendent of Financial Institutions Canada (OSFI) — says they were never intended to address rising housing prices in Canada.
So, are falling housing sales and prices an intended or an unintended consequence of the stress test?
There is little doubt that housing markets have weakened since January 2018, when the stress test first came into effect across Canada. In greater Toronto, housing sales in February 2019 were 2.4 per cent lower than a year ago. But sales in February 2018 had already declined 35 per cent from those recorded in February 2017.
Housing sales in greater Vancouver were even weaker, with February 2019 sales 33 per cent lower than the same month in 2018. In fact, February 2019 sales are 43 per cent lower than the 10-year average for sales in February.
Housing prices also depict similar trends in Vancouver. A quality-controlled index of housing prices revealed that prices in February were down by six per cent yearover-year. The same metric for housing prices in Toronto was up by 2.4 per cent.
Evan Siddall, who heads the Canada Mortgage and Housing Corporation (CMHC), believes that the stress test is bitter medicine that is working fine. He thinks the critics are “short-sighted” and “aren’ t thinking beyond the next commission cheque.”
Siddall credits the stress test for lowering housing prices. “Houses are something like $40,000 (5.3 per cent) cheaper in Toronto because of the stress test,” he recently noted.
“So, while the medicine may taste awful, it’s working well,” he concluded.
Based on Siddall’s comments, one might assume the tests were designed to make housing cheaper, but Carolyn Rogers, the Assistant Superintendent at OSFI, dispelled this misconception in a recent speech to the Economic Club of Canada.
Addressing the criticism of the stress test, she clarified that while some assumed it was “designed to target escalating home prices” that was not the case.
Rather, she explained, the stress test “was designed to target mortgage underwriting standards.” In her words, the test was intended to provide a safety buffer so that borrowers do not “stretch their borrowing capacity to its maximum.”
As such, the stress test has been successful in lowering the prevalence of high-risk lending. A recent report by the Bank of Canada revealed that the “number of new highly indebted borrowers has fallen” and the quality of credit has improved while the quantity of credit being offered has declined significantly.
The first phase of the stress test in 2016 addressed high-ratio mortgages where the loan-to-value ratios exceeded 80 per cent. In particular, the test targeted highly indebted borrowers whose loans were more than 4.5 times their annual income.
In January 2018, the stress test was expanded to include low ratio mortgages (loanto-value ratios under 80 per cent). Whereas the first iteration of the stress test in 2016 dramatically reduced the share of new high-ratio mortgages involving highly-indebted borrowers, it did not reduce as much the share of total mortgages extended to highly-indebted borrowers.
However, when low-ratio mortgages became subject to the stress test in January 2018, a decline in the share of total mortgages extended to highly-indebted borrow- ers realized.
In summary, the stress test made progress in achieving its intended target of reducing the share of highlyindebted borrowers. Declining housing sales and prices came along for the ride (whether they were truly an intended or unintended consequence, we will leave to readers to decide).
But what about other unintended consequences, such as driving those who do not qualify for a mortgage under the new regulations to lenders that are not regulated by OSFI and who might charge significantly higher interest rates?
Remember, the stress test is only enforced on federally regulated lenders. Those governed by provincial authorities or otherwise are not affected.
OSFI is correct in ensuring that a “margin of safety” is maintained at a time when the interest rates are historically low and consumer debt levels are high.
However, economic conditions are seldom stagnant, and policies must adapt to market conditions. If OSFI independently finds that the market conditions have changed sufficiently in the past 14 months, a review of the margin of safety might be a good thing.