Why does the BoC need to keep raising its key interest rate?
Current economic forecasts, including the Bank of Canada’s, show the domestic economy running at “potential” by mid-2012. That means economic output growth will then be running at what we might think of as full capacity. If growth were to run at a higher rate, inflationary pressure would set in, which is what the bank wants to avoid. And because monetary policy is effective only with a substantial time lag, there is always an incentive to act sooner rather than later. Therefore, the bank will increase its administered interest rates over the coming year, and we should expect and plan around increases in stages. The bank’s overnight interest rate target is likely to increase at least two percentage points over that period.
Do you still believe CMHC is a liability to the Canadian economy? Why?
The Government of Canada backs CMHC, which is the dominant provider of mortgage insurance in the country. While its gross liabilities exceed $500 billion dollars in mortgage debt, its net exposure is much less because the gross amount does not reflect what borrowers have paid down or what may be recovered if and when they sell the underlying property. That said, a significant downturn in the economy, if it happened and was matched by a general fall in housing prices, could lead to defaults that could eat through CMHC’s equity – about $10 billion – pretty quickly, leaving taxpayers on the hook for the rest.
Why would it be better to have more private mortgage insurers in the market considering that south of the border the U.S. government had to bail out private-insurer AIG to the tune of $180 billion? Doesn’t that show losses in the private sector can still be a public liability?
The reason for having more competitive suppliers in the mortgage insurance marketplace is to diversify sources of capital and risk management models, so that the likelihood of a particular set of failures landing on the federal tab is lessened. One layer of protection against that risk is reinsurance, and if the federal government was (instead of providing mortgage insurance directly) to focus on ensuring a vibrant reinsurance market, the likely risks to the federal tab could be lessened. Private sector losses can in some situations become public liabilities – the issue is whether appropriate incentives, safeguards and accountabilities are in place, so that the impact of bad surprises is minimized.
Does the federal government need to stop tinkering with the mortgage rules? What should the feds’ role in the real estate market really be?
The Bank of Canada’s monetary policy toolkit is the one best able to respond to macroeconomic ebbs and flows. Mortgage rules should focus on disclosure, safety and soundness. After that, it’s “set it and forget it.”
What do you foresee happening in the Canadian real estate market for the rest of 2011?
On a global level, continuing strength in energy and commodity prices – which won’t trail off soon – will support demand in the regions of Canada that produce those commodities. The impact on housing prices, however, will also depend on supply conditions, as people in the market know very well. Against that, Canadians are historically somewhat over-invested in residential housing assets, but on the question of how these influences will balance out, I don’t have a strong view.