Watershed or Landmark? – Carney, Flaherty, Harper All Warn – Risk Of “Brutal” Reckoning

Perhaps a watershed; at least a landmark. Very strong warnings this week from Mark Carney, Jim Flaherty, and Stephen Harper have been widely quoted all over the RE blogosphere. We post them as a bookmark,  for the sake of being able to reference them as having occurred ‘here’ in our ongoing chronology of stories from the Vancouver Bubble ‘n Bust. -vreaa

From Remarks by Mark Carney, Governor of the Bank of Canada, Economic Club of Canada, Toronto, 13 Dec 2010
“Historically low policy rates, even if appropriate to achieve the inflation target, create their own risks. Aside from monetary policy, Canadian authorities will need to remain as vigilant as they have been in the past to the possibility of financial imbalances developing in an environment of still-low interest rates and relative price stability. …
The perception of low rates for long [can] potentially distort behaviour in public, financial, corporate and household sectors. …
Encouraged in part by low interest rates, Canadian household credit has expanded rapidly during the recession and throughout the recovery. As a consequence, the proportion of households with stretched financial positions has grown significantly.
In a series of analyses over the past year the Bank has found that Canadian households are increasingly vulnerable to an adverse shock and that this vulnerability is rising more quickly than had been previously anticipated. …
Without a significant change in behaviour, the proportion of households that would be susceptible to serious financial stress from an adverse shock will continue to grow. …
Owing to the declining affordability of housing and the increasingly stretched financial positions of households, the probability of a negative shock to property prices has risen as well. …
Even if the growth in debt continues to slow, the vulnerability of Canadian households is unlikely to decline quickly given the outlook for subdued growth in income. In addition, private consumption is unlikely to be bolstered by gains in house prices going forward. …
Prolonged periods of unusually low rates can cloud assessments of financial risks. …
The Bank’s advice to Canadians has been consistent. We have weathered a severe crisis–one that required extraordinary fiscal and monetary measures. Extraordinary measures are only a means to an end. Ordinary times will eventually return and, with them, more normal interest rates and costs of borrowing. It is the responsibility of households to ensure that in the future, they can service the debts they take on today. Similarly, financial institutions are responsible for ensuring that their clients can service their debts. …
Low rates today do not necessarily mean low rates tomorrow. Risk reversals when they happen can be fierce: the greater the complacency, the more brutal the reckoning.”

“In the housing market, the Canadian government has already taken important measures to address household leverage. These include a more stringent qualifying test that requires all borrowers to meet the standards for a 5-year fixed-rate mortgage as well as a reduction in the maximum loan-to-value ratio of refinanced mortgages and a higher minimum down payment on properties not occupied by the owner. In addition, the Bank of Canada’s interest rate increases reminded households of the interest rate risks they face. These measures are beginning to have an impact. Canadian authorities are co-operating closely and will continue to monitor the financial situation of the household sector. These defences should go a long way to mitigate the risk of financial excesses. But the question remains whether there will still be cases where, in order to best achieve long-run price stability, monetary policy should play a supporting role by taking pre-emptive actions against building financial imbalances. As part of our research for the renewal of the inflation-control agreement, the Bank is examining this issue. While the bar for further changes remains high, the Bank has the responsibility to draw the appropriate lessons from the experience of others who, in an environment of price stability, reaped financial disaster.”

“These are extraordinary times. A massive deleveraging has barely begun across the industrialised world. …
The challenges we face have only just begun.
Cheap money is not a long-term growth strategy. Monetary policy will continue to be set to achieve the inflation target. Our institutions should not be lulled into a false sense of security by current low rates.
Households need to be prudent in their borrowing, recognising that over the life of a mortgage, interest rates will often be much higher. …
Now is not the time for complacency.”

Mark Carney in interview on BNN 14 Dec 2010
“You always get yourself in trouble if you only lend on the basis of assets, ultimately the debt service is as important, the debt endures, the asset prices go up and down.. And, when countries have got themselves into trouble in these situations, … to only look into that aspect of it is to make the classic mistake… When you have, in fact, asset based lending, which then drives asset prices up for a time which then allows more asset based lending and consumption until it doesn’t. And then when the cycle reverses it’s pretty brutal, and the debt endures. People in Ireland, people in Iceland, people in the United States, who took out big mortgages on assets that were worth a lot more for a long period of time found out that the assets not worth very much but the debt is the same as when I took it out.”
“No country can grow debt faster than income persistently.”
“Debt levels are unprecedented in this country.”
“The level of vulnerable households is high.”

Finance Minister Jim Flaherty 13 Dec 2010 – “Our parents were more inclined to pay off that mortgage as soon as possible, and some Canadians are not as inclined to do that now. I encourage them to do it. The fear is that were we to see sharp rises in interest rates or were we to see sharp rises in unemployment, that a significant number of people might not be able to afford their debt obligations.”

Prime Minister Stephen Harper 13 Dec 2010 – “We are a free country and people are entitled to make their own financial decisions. This is a matter that is of concern to the government, we continue to warn Canadian households that interest rates are unlikely to go down.”

4 responses to “Watershed or Landmark? – Carney, Flaherty, Harper All Warn – Risk Of “Brutal” Reckoning

  1. Talk is cheap. Almost as cheap as my mortgage payment LOL.

    Try to talk down the market and then do nothing when securities markets go scurrying in response to the chest beating. Right from the central bank playbook.

  2. I think it is great that they are warning people but I don’t think people are listening. People will only pay attention when interest rates rise or the amortization period is shortened. The only thing that matters is what the monthly payment is today, what the monthly payment is next year or 5 years from now people don’t think about.

    This weak my sister bought a house in Toronto for $450K with a 60K down payment and a 35 year amortization. House was listed for 425K and there was a bidding war.

    She had been looking for since June, she is a first time home buyer. No amount of data was enough to get stop here from buying. I built a spreadsheet for her and showed her how much the interest + property tax + CHMC fees + land transfer tax + insurance would cost her which would give her about $1500 to $1800 that she could pay for rent and still be worse off than buying. Still she and her husband wanted to buy a place. I sent her the links to the articles quoting Carney, Harper, and Flaherty and still I was accused of being too pessimistic.

    I showed her the evils of the 35 year amortization, she insisted that they will pay it off faster. I asked on on what basis she makes that claim. Oh we will make more money, I hope she does but who knows. When i challenged her on what about when you have kids and have more expenses, oh well I got accused of being pessimistic.

    I guess buying a house has a major emotional component and the trends is that place more value on owning rather than renting. In the final analysis my sister wants a house and the banks are willing to her a mortgage and monthly payment that she can afford now, so she buy the house.

    I think the market will not correct until people are afraid, and on one is going to be afraid until rates go up, or amortizations are shorted or something else happens. When you have been driving at 150KM/h it does not seem that you are going fast until you have to break really fast.

    • Of all the arguments I hear out there, that those of us who are bearish are being “pessimists” is the weirdest one to me. I could accept “overly-cautious”, or even “wrong” – in time, time will tell. But right now, I can rent bigger and in a better location for a thousand bucks less than owning and not have to worry about the roof: I’m not entirely sure how pointing that out and suggesting it’s a financial strategy that leaves other options open can be construed as “pessimistic”, regardless of what the market ever does.

      But you hear it all the time. That bears are gloomy, or something. I think bears just value buying low more than selling high. Nothin’ gloomy ’bout it.

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