Mark Zelmer gave a speech touting OSFI at the C.D. Howe Institute Housing Policy Conference titled OSFI is on the Case: Promoting Prudent Lending in Housing Finance:
But, by same token, it is clear that the ability of the household sector as a whole to absorb major shocks is less now than it was a decade ago. Moreover, with interest rates near record low levels, there is not much scope for interest rates in Canada or the United States to fall further – something that helped people weather storms in the past. Governor Poloz recently noted in his testimony before the Senate that the Bank of Canada continues to expect a soft landing for the housing market and Canada’s household debt-to-income ratio to stabilize.Footnote 2 But he also acknowledged that imbalances in the housing sector remain elevated and could pose a significant risk should economic conditions deteriorate.
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So from a prudential perspective, the environmental risks associated with lending to households are higher now than in the past. With interest rates expected to remain exceptionally low and household indebtedness high, these risks are likely to remain elevated for the foreseeable future.
Well, in the first place, he disingenuously declines to acknowledge the fact that from the banks’ perspective, a huge proportion of their mortgage debt is just as credit-worthy as Canada bonds, given that it’s insured by CMHC. This is the chief imprudence in the current situation and, I believe, the primary source of whatever bubble there might be in the housing market.
He then tries to insert a little revisionist history into the equation:
You may wonder what more a prudential supervisor really needs to do if lenders and private mortgage insurers are well capitalized. But in stress situations, creditors and investors often lose confidence in these institutions before they run out of capital. Recall that some financial institutions lost access to funding markets in the midst of the global financial crisis even though they were reporting healthy regulatory capital ratios at the time. Sitting back and relying on capital is not enough for either financial institutions or prudential supervisors.
Yes, and I also recall that numerous financial institutions went bust even though they were reporting healthy regulatory capital ratios. So let’s not have any more nonsense about healthy regulatory capital ratios.
In the wake of the global financial crisis, many observers are suggesting that bank regulators need to think about their tool kit and employ macro‑prudential tools like changes in loan‑to‑value limits to lean against rising environmental risks. But at OSFI we believe it makes more sense to promote prudent lending all of the time. Hence, the 80 per cent loan‑to‑value limit on conventional mortgages enshrined in the federal legislation; and, where necessary, deep dives like the ones I just described in the current environment.
Conveniently, none of these observers are named or cited, so we can’t check up on this. But the bit about ‘prudent lending’ is a little odd: is he saying that extending a mortgage is imprudent even when it carries a 100% government guarantee?
By the same token, let me note the focus in the B-20 and B-21 guidelines on governance and risk management principles. Such principles are meant to stand the test of time. They do not lend themselves to hard limits that one can vary in response to changing economic and financial conditions.
Frankly, OSFI generally prefers to take a principles-based approach in setting our regulatory and supervisory expectations. Hard limits like the 65 per cent LTV limit on Home Equity Lines of Credit (HELOCs) are more the exception than the rule. The key advantage of a principles-based approach is that it provides us the flexibility we need to tailor supervisory expectations to the situation at hand. This avoids safe harbours and compliance mentalities that breed complacency on the part of regulated entities, not to mention supervisors. Instead, principles help to underscore the point that regulated institutions are expected to use judgment and apply the guidelines to the situations they face on the ground within their own organizations.
And this is exactly the problem: the last thing we need is more herd mentality and nod-and-wink regulation; we know where that got us with Manulife in Canada and other institutions in other places.
All his points about high consumer debt-to-income ratios and so on is not an indicator of the need for principles-based regulation; it is indicative of a need for a counter-cyclical capital buffer. Why don’t we see any interest, let alone any research, into a counter-cyclical capital requirement based on debt-to-income? Funded by, but certainly not executed by, OSFI – we know what happens when those guys pretend to be academics.
At the end of the day, mortgage lenders and insurers must accept that they are responsible for the loans they are granting and insuring, and thus the risks they are running.
Ha! No they ain’t, buddy. The Feds are responsible for CMHC losses … no moral hazard there, no sir, not one bit!
Update: On a related note, Mark Gilbert of Bloomberg writes about Mark Carney’s Central Bank Mission Creep:
No matter how Governor Mark Carney dresses it up, the Bank of England’s decision today to impose caps on mortgage lending amounts to an explicit effort by the central bank to manage asset prices.
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Today, he said: “We don’t target house prices, we care about indebtedness. We think that price dynamics in the housing market are going to slow in about a year as incomes pick up.”There was also a half-buried message in today’s press conference about the central bank’s reluctance to raise interest rates for fear of missing its target of getting inflation back up to an annual pace of 2 percent. By imposing restrictions on lenders, “monetary policy does not need to be diverted to address a sector-specific risk in the housing market,” Carney said. In other words, if Carney can cool the housing market with tighter controls on mortgages, he can keep rates lower for longer.