David Dodge, former governor of the Bank of Canada, on BNN ‘Squeeze Play’, 25 Jan 2011 –
Interviewer: How significant was [the recent mortgage tightening]; was it just cosmetic?
David Dodge: No, look, you’re always working at the margin, but let’s be very clear: a home purchaser is able to borrow at very low interest rates because you and I as taxpayers essentially guarantee that, when it’s a high ratio mortgage… and so it’s not at all unreasonable, again for us as taxpayers, to say, “Look mister borrower, you’ve gotta have an equity stake in this as well… so that if things go really bad, it’s not all on the Canadian taxpayer, part of it is on you.”
So, there is that issue, and that is a long standing issue, it’s an issue which I raised back in 2005… we didn’t have it quite right… I think the adjustments that the government have made are indeed absolutely appropriate.
We face a funny situation at the moment where low interest rates are appropriate for the economy as a whole but where do they have their maximum impact? They have their maximum impact on the housing market. And so it is appropriate to use that quantitative tool (ie the terms and conditions under which you can get a CMHC insured mortgage), to use that tool to dampen somewhat that effect because you really don’t want the Bank of Canada to have to raise rates inappropriately just to cool the housing market. So I think it was absolutely appropriate what the government did.
Interviewer: Do you think though it’s really going to be enough if you’ve got, basically, record household debt now?
Dodge: Wait a second, wait a second.. this is operating in a particular market, in the housing market, and what we saw was that Canadian housing prices fell sharply but then fully recovered and then overshot. So house price to income, house price to rent at the moment is at historic highs. And so we do risk, in the housing market, we risk a bubble forming, which is not helpful to anything/anybody… so I think the government took exactly the appropriate action… I might have wished they’d taken it a little sooner, but they took exactly the appropriate action, and they deserve full marks for that.
Interviewer: Is the whole credit thing a big deal if your real estate is worth more?
Dodge: Well, hang on (laughs) that was the box that the Americans got themselves into.. they bet on house prices going up ad infinitum… and of course they fell, in some places by more than 50%… and then you have an enormous problem… so I think this is absolutely appropriate policy, given that it is appropriate for the BOC to be very accommodative at this point in time.
Interviewer: But, David, what about the CMHC… massive expansion of their balance sheet from $150B now north of $500B they’ve been approved up to $600B, that’s all on the taxpayers books, why didn’t the government say//… It’s like Fannie and Freddie in the States.. that didn’t work out to well… putting a lot of that on the balance sheet of the tax-payer.. shouldn’t the government be trying to claw CMHC (back)
DD: Whoaa-whoaa…// The Canadian mortgage bond program, that’s what you’re talking about, it’s already insured by CMHC… We have the risk already… whether those mortgages are packaged in a bond, or not… The reason we have that program, why it was expanded so rapidly in 2008 and 2009 and that was to ensure that the banking system had the liquidity to carry on. Now, that program, over time, probably can be wound down a bit, so that it doesn’t add to your and my risk as a taxpayer… we’re already on the hook, we’ve ensured those mortgages
Interviewer: Almost 70% of all residential mortgages are now insured and CMHC is the insurer of last resort
DD: And that is why it is important that everybody have an equity stake in their house! (chuckling)
[*In an earlier part of the interview, Dodge also intimated that many would say that at a 85c loonie we would more or less make Canada “competitive with the Americans”.]
Dodge always seems very sensible.
We are pleased to see him mentioning fundamentals such as price/income, price/rent, and how he emphasized their historic extremes. One hopes that those who consider these factors unimportant would note that Dodge still sees them as crucial (but we’re not going to hold our breathe on that one).
We respectfully disagree with him when, like some other commentators, he implies we are able to avoid a bubble via mortgage lending tightening: there already exists a bubble, worse in certain markets. If ‘historic extreme’ separation of prices from fundamentals doesn’t alert us to this, what would?
He repeatedly reiterates that he sees the mortgage tightening move as ‘appropriate’. But he also points out that he would have been more hawkish and moved earlier.
The interviewers are on the correct track when they ask him whether the changes are enough.
It would have been nice to have seen them ask him direct questions about the implications, say, of a price/income ratio of 9.3:1.