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’.
Off the top, a move from 35 to 30 means going from $300K to $280K principal with the same monthly payments. That’s about a 7% drop in what someone can afford, equivalent to roughly a 0.5% rate hike for those who insist on maxing out their GDS/TDS.
Removing HELOC financing insurance seems to be an effort to remove a loophole allowing some people to “sneak in” to a high leverage loan. As A# accountant on VCI stated, an owner can still refi.
It isn’t a large move so it shouldn’t have a major impact. However there is a psychological factor involved here. Clearly the gov’t is sending a strong message that the pendulum has begun to swing the other way and they will not support or provide further policy to stimulate housing. This could really push a number of people to list now knowing it is not going to get better.
I think we will see a large number of listings over the next 3-4 months. This could really have an impact on prices.
One would imagine that the Department of Finance would use very sophisticated modeling to determine the probable effects of various forms and degrees of tightening.
It is, however, impossible to accurately model the effects of changing psychology. That is the ‘tipping point’ stuff, as the herd shuffles from one side of the boat to the other.
Can government engineer a deconstruction of the bubble?
Central planners always start with the best intentions of trying to do good.
It’s actually an interesting question: has anyone ever reasonably claimed to have successfully steered a bubble to a soft landing? (Obviously premature claims of such success are readily dismissed.)
Royce-> This has been discussed elsewhere in the blogosphere. As far as we can tell, there are no examples of genuine bubbles achieving managed soft landings. Amazing, especially since there are literally hundreds of bubbles that have occurred in all sorts of markets.
I think tipping point is a more appropriate model. Who knows what the trigger monthly payment will have to be to cause enough buyers to stop buying.