Minister of Finance Jim Flaherty announced 17 Jan 2011 that mortgage lending terms will tighten. Maximum amortization periods will drop from 35 to 30 years, HELOCs will not be insured by CMHC, and individuals will only be able to refinance up to 85% of their property’s market value, down from the prior 90%.
These small incremental measures are designed to slightly cool off the market, and are an attempt at engineering a soft landing. Flaherty is hoping that a ‘faucet’ model applies regarding lending and the RE market: The hope is that as you tighten a little, the market slows a little. If this model applies, and you do that incrementally, you can potentially get it ‘just right’.
However, is that how the market actually works?
What if a ‘tipping point’ model better applies? In that case, there is going to be a non-linear response: as some point in the tightening process, a threshold is crossed, and large changes will rapidly occur. Like worn brakes going from smooth braking to suddenly seizing, like an egg being nudged over the edge of a table.
In Vancouver, the RE bubble has been fueled by very loose lending. Prices have pressed upwards, always at the very edge of what ‘affordability’ based on monthly payments has allowed. There will come a point where one more tightening nudge will halt that upward advance in prices. Today’s changes may very well be that nudge. And when that upward price advance ends, other factors will suddenly come into play. We believe that the very most critical change will be the psychological one that occurs when a majority of owners go from believing ‘this market is only going up’ to ‘this market could go flat or even fall’.
Many, many Vancouver owners are holding onto properties based on the premise that prices only go up. The moment that belief is seriously challenged, we believe that these holders will begin to liquidate their RE holdings. We are not just referring to the obvious speculator/flippers here, although they do make up an important minority. We are talking about the large number of regular citizens who have their financial futures dependent on the real estate market. They may be holding second and third properties, or their financial well-being may be largely dependent on the equity in their principal residences. There is far more ‘speculative holding’ in this market than is widely understood or acknowledged.
Sure, we had price drops before. At the end of 2008/beginning of 2009, prices dropped 15% in 3 to 4 months. But most owners had no chance to respond to the drop. It takes a few months to decide to sell real estate, and to act on it. Before the vast majority of owners could respond, interest rates were dropped to zero and the market was juiced. So slowly do things move in the RE markets that some owners may only have heard of the drop and bounce after the fact. When the market next turns, there will be a more relentless grind down. There will be no fiscal loosening to rescue a previously overextended market, both the MoF and the BOC appear to have made that clear. Price drops will beget price drops. The ‘virtuous’ cycle of price rises begetting more price rises will turn ‘vicious’.