Newest homebuyers could pay the price for Canada's financial stability
Bank of Canada says financial system is sound, but the overborrowed may suffer
As in previous years, reading the Bank of Canada's annual Financial System Review can be enough to send your pulse racing, and not in a good way.
On the bright side, this time around, those most likely to suffer from the bank's warnings will be young enough to withstand the health effects of heart palpitations.
The main reason why the Financial System Review can be worrying — just as it was last year, when it warned of the dangers of rising mortgage debt when few thought high inflation would be a problem — is that the Bank of Canada's main aim is to tell us all what could go wrong, to offer solutions and to help us prepare.
Unexpected but worrying
Again this time, as Bank of Canada governor Tiff Macklem and his chief deputy, Carolyn Rogers, laid out their most ominous scenarios at Thursday's news conference, they added a proviso.
"This is not what we expect to happen," Macklem assured reporters after laying out a chilling series of potential events that could seriously damage the fortunes of those who poured their savings into a home during the pandemic as prices soared 50 per cent and interest rates plunged.
For those people, many of them young buyers hoping to get a first foot on what they expected would be a "property ladder," the dire warnings may sound louder than the reassurances.
Macklem and Rogers insisted that since the vast majority of Canadians had paid off their mortgages or had manageable debt, the wider financial system was in little danger. But due to the absolute necessity of fighting inflation with rising interest rates, people who got in at the peak may be in trouble, especially if they lose their jobs. With jobs numbers on Friday predicted to remain strong, that seems far away, but things can change in a period of rising rates.
"If the economy slowed sharply and unemployment rose considerably, the combination of more highly indebted Canadians and high house prices could amplify the downturn," Macklem said.
The central bankers reminded us that, in theory, the most recent buyers had a financial pad since "stress test" rules required buyers to have the financial capacity to pay a lot more than mortgage lenders were asking. But that did not mean young buyers had set aside the cash in an emergency account. Nothing prevented them from spending it on the inevitable necessities that come with a new home.
"If those highly indebted households lose their jobs, they would likely need to reduce their spending sharply to continue servicing their mortgage," Macklem added, though where highly indebted and newly unemployed people would get the cash to do that is far from obvious.
Moderation or default?
Neither questioners nor central bankers uttered the word "default," but if conditions really were to get as bad as the bleak scenario above, the number of mortgage defaults would likely rise.
Similarly, while the central bankers repeatedly talked about a necessary "moderation" in the housing market, there was no mention of the kind of serious decline in prices that some analysts are predicting.
Just as in last week's news conference with deputy governor Paul Beaudry, reporters asked Macklem to respond to calls by Conservative leadership front-runner Pierre Poilievre for the bank governor to resign, saying he let inflation get out of hand.
Although Macklem tried his best to deflect the questions, it is hard to see critics being mollified if a surge in interest rates helps spur defaults among young and vulnerable recent homebuyers.
Part of the logic for offering such a bleak forecast might be as a warning to the many Canadians who are still borrowing to buy houses at levels they may regret.
Figures released last week by TransUnion, a company that monitors household debt, shows despite the threat of rising rates, Canadian borrowing in the first three months of this year — including mortgages and lines of credit — was up more than nine per cent from the same period in 2021.
It seems everyone has a take on inflation and its consequences.
The World Bank and the Organization for Economic Co-operation and Development have warned of the dangers of stagflation. U.S. Treasury Secretary Janet Yellen testified to the U.S. Senate that high inflation would persist. Even rapper Cardi B and billionaire Elon Musk have weighed in with predictions of a recession, Canadian Business reports.
According to Macklem, the situation remains "delicate," a term he used more than once.
After what he called the biggest economic shock he hoped we would ever face, including "two years of a pandemic and unprecedented economic and social upheaval," the governor implied he would reluctantly accept recession as the price of getting inflation under control.
The clear implication is that for financial stability, inflation is now a more important problem than a weakening housing market and that some of those who ignored last year's warning that surging mortgage borrowing was an accident waiting to happen may be sacrificed for the greater good.
"The housing market, it's an important part of the economy," Macklem said. "We are watching it closely, but our focus ultimately is on the whole economy and in getting inflation back to target."
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