David Dodge – “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.”

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”.]

Our comments:
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.

22 responses to “David Dodge – “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.”

  1. He’s sensible… That’s why he the FORMER Govenor of the BOC… All sensibility left when Flaherty became finance “mini-czar” and Harper became “Our Glorious Leader”…

  2. Thanks for transcribing this into the archives. I agree David Dodge is on the mark with what fundamentals to monitor but I think he got on the wrong train when it comes to fiscal policy. If you look at past recessions around the world and what typically happens when an economy successfully starts emerging and growing at full capacity, it is through residential investment.

    In the latest recession, housing was already overvalued as measured by price-rent and price-income ratios. The government, incorrectly in my view, thought that by encouraging RI they can engineer a recovery: if RI leads a recovery why not juice it up?

    The problem is pumping up RI when the fundamentals are poor is mixing up cause and effect and — guess what — debt was poured into unproductive assets when in past recessions debt was poured into much better-performing assets. Now debts are high relative to incomes. That is a big difference from past recessions, as I’m afraid we’re about to find out.

  3. The real problem is that Canada is a Three-Trick Pony:
    Oil and gas, consumption, real estate. That’s it. That’s our country.
    The most expedient way for the government to put some lipstick on the GDP pig is by pumping up real estate.
    Drinking poison to quench thirst, indeed.

  4. Anybody notice that the loonie dropped below parity by the close on Friday?
    I suspect we’re heading for the low 90’s, over 6-18 months. Perhaps even high 80’s.

    • Entertainment and game development Vancouver could really use the drop.

    • Housing Bubble in Canada is about to burst

      The loonie dropping would help the economy, which is always a good thing

    • I don’t see that.

      The US isn’t any less volatile than last week. There were a few people who probably tried to cash in in the hope to buy back in later but a drop in the loonie vis-a-vis the Greenback by any significant margin I can’t see.

      If anything if the uncertainty spreads through the Middle East (as yesterday some people seem to hint at) we could see a rise in the Loonie as we still DO have tar that people would want. If there is the fear that Saudi Arabia etc. could be caught up in a “revolution” investors could actually flock to the Loonie for later use.

      But all of this is speculation, it seems things have begun to move that we don’t understand yet and how the fear will drive the cash and where is still open.

      Best advice: Hold onto your pants, it’s going to be a very wild ride.

  5. He sounds like a reasonable big picture guy. But he was gov during the long years of the run-up. Did he make any warning noises then?

  6. David Dodge and Mark Carney both talk a good game, but their actions speak louder.

  7. Good post. Shows they are cognizant of the risk, which is more than can be said for our neighbours to the south who were mostly blind to this issue.

    There’s really nothing more that can be done. They can’t raise rates for a variety of reasons so their only tools are to tighten mortgage requirements. I expect (hope for) more tightening but of course prudence (ha-ha) is of utmost importance here.

    BTW, you quoted me as ‘taunting’ the bears. That is false. I was merely pointing out that being bearish is itself risky and bear blogs are so popular that it could be seen as an inverse indicator (pent up demand).

    Also, the blog seems to be getting busier, so kudos. I do enjoy the analysis.

  8. blammo-> sorry if I offended or misread.

    The bear blogs may have gotten more popular, but the bears still only represent a small sliver of the players. The vast majority of people in Vancouver with interest in the RE markets remain besottedly bullish. It’s telling that almost all public analysts call for ‘modest increases’ going forward. No mainstream analysts are calling for significant drops.

    Agree that ‘being bearish is itself risky’, but only so far as there is risk in any position. The risks of being bullish this market are, IMHO, far greater than of being bearish.

    There may be some ‘pent up demand’ in the bear camp but that is trumped by the amount of demand borrowed from the future by the criminally under-aged mortgage rates. So, the demand on the sidelines is, I would estimate, below historic average levels. And, if you’ve followed this blog, you’ll know that I expect demand to plunge as prices drop (given the degree of speculative-component buying inherent in the market).

    Another factor regarding bear demand: At what point would bears who are prospective buyers step into the market?
    My expectation is that some will do so at the 2009 lows (15-20% off from here, depending on area), and this will likely cause a small price bounce at those levels, but that many are expecting return to 2005, 2004, 2003 prices, and won’t try to catch the falling knife. Thus, we don’t expect a massive amount of buyers to step in and rescue this market after a small 10-15% pullback.

    • “At what point would bears who are prospective buyers step into the market?” – VREAA…

      Of course, I can only speak for myself – but the only point at which I might (stress on ‘might’) be tempted would be in the 30-40 cent on the dollar (off peak prices) range… IMHO, in certain BC markets – for certain types of RE… that’s going to be much sooner than many think.

      As for your CDN dollar prognostications, VREAA… I think you’re going to be surprised to the upside by the Loonie’s resilience/buoyancy in the currrent GlobalMacro environment of strategic uncertainty (i.e. energy/agriculturals)…


      • Nemesis -> My RE buy signal would be similar to yours.

        Obviously I can’t be sure about the USD/loonie. Currently I’m anticipating a deflationary wave with gen.markets, commodities, gold, pm.stocks, commodity currencies (loonie, aussie), all falling against the dollar. May have started a serious leg late last week. We’ll see.

  9. blammo-> I’ve just re-read your post that I called a ‘taunt’. I realize I was responding to you calling the bear voices ‘The Choir’, implying that the bearish position is akin to that of a mindless cult.
    It’s fair to raise that argument (and it’s a ‘taunt’ at the same time!).
    However, we don’t think it holds water. There are too many sound economic and historic fundamental arguments backing the bear-case. Many bears have already come to those conclusions about the markets, from their own reading and analysis, before ever reading a bear blog (that was certainly my own experience).
    If anything there’s a better argument that the ‘this time it’s different’ crowd are cult-like. After all they are the ones who are asking you to believe that Vancouver can continue a levitation act against the principles of economic and mathematic gravity.

  10. bear blogs exist until the bloggers buy and then quit blogging. Until then, they continue chewing the same thing over and over.

    • Fred, are you familiar with ‘capitulation’, and what that means for markets?

      For the bear bloggers to ‘buy and quit blogging’ would the most screaming sign of a top yet. Once the bears are ‘in’, everybody is in, and then we crash. As it is, I don’t believe all the bears will capitulate, and I don’t believe it is necessary for the bears to stop blogging before a crash.
      Many will leave town in disgust, which is a different (and healthier) form of capitulation.

    • I don’t blog but I can tell no chance in hell I am buying until fundamentals make sense!

  11. You’re the shizzle VREAA! This is good stuff!

    • Thanks Ben, that means a lot, coming from you.*
      Of course, guys like blammo simply think we’re mindlessly wailing in tongues, all from the same hymn book.
      What can we say? It’ll happen when it happens.

      *[For readers who don’t yet know, Ben’s blog, financialinsights has fast become the best Canadian economics/RE blog around.]

  12. Pingback: David Dodge interview on BNN: “House price to income, house price to rent at historic highs” | Financial Insights

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